Success? The Russia/Ukraine/EU gas agreement

On 29-30 October the last round of trilateral negotiations between Russia, Ukraine and the European Union was carried out in Brussels, which ended with the conclusion of an interim agreement (the so-called winter package) on the Russian-Ukrainian gas dispute. The main provisions of the document are based on a compromise proposal tabled in September by the EU Commissioner Energy Günther Oettinger, which allows each party to treat the agreement as a negotiating success: Ukraine, because of the prospect of the resumption of Russian gas supplies, and avoiding major concessions to Gazprom; the EU, because the security of supplies of Russian gas to European customers was increased, a success to round off this term of the European Commission; and Russia, as it will recover part of Ukraine’s debt, and has ensured the safer transit of its gas to the EU. Russia has decided to sign the agreement because it sees the terms as closest to its own negotiating position, and also shows good will toward the EU, in the hope of improving the image of Gazprom. The fundamental difference between Russia and Ukraine in their approaches to formulating the rules for gas cooperation means that a lasting, systemic solution to the dispute between them in the coming months is unrealistic. The Ukrainian side is counting on a favourable decision from the arbitration in Stockholm.

The nature of the agreement

The agreement appears to be primarily political in nature. The key elements of the compromise were included in the intergovernmental protocol signed by the energy ministers of Russia and Ukraine, Aleksandr Nowak and Yuriy Prodan, and the EU Energy Commissioner. Its content does demand specific commitments from Naftogaz and Gazprom, but the two companies are not themselves formally parties to the protocol. All the legal aspects of its implementation have been dealt with in an unpublished technical annex to the Russian-Ukrainian gas contract from 2009 which was signed by the CEOs of Gazprom and Naftogaz. Due to the undisclosed details of the annex, as well as possible behind the scenes deals (prior to the agreement, there were reports of telephone consultations between the president of Ukraine and the German chancellor), it is hard to clearly assess the legal consequences of the agreement (and thus what real concessions the parties have made), which could be crucial in the context of proceedings before the arbitral tribunal in Stockholm. Nor is the nature of the guarantees offered by the EU to Ukraine clear; according to Ukraine, the EC President Jose Manuel Barroso sent a letter to President Poroshenko on this matter, the significance of which is unclear from a legal point of view (the letter was not published). These ambiguities mean that different interpretations of the Brussels agreement are possible.

The Ukrainian perspective

In the agreement, the Ukrainian side managed to win some of their demands formulated during the negotiations with Gazprom. Firstly, Ukraine has secured the supply of 4.6 bcm of gas in the winter, avoiding the need for a drastic restriction of gas supplies for industry (30%) and domestic purposes (20%). Secondly, the price of gas will not exceed US$385 per 1000 m³, and – due to the lower price of oil – will probably be lower (respectively US$378 in the fourth quarter of this year, and US$365 in the first quarter of 2015). Thirdly, Ukraine agreed to repay part of its debt (US$3.1 billion, of which Naftogaz paid US$1.45 billion on 4 November), but it is a much smaller sum than Gazprom has demanded (US$5.3 billion). As a result, the parties accepted that the final size of the debt will be determined by arbitration. Fourthly, the Ukrainian side has managed to suspend the ‘take or pay’ clause for five months, which had been a key demand since the beginning of the negotiations. Kyiv interprets this as a success, which will strengthen its position during arbitration.

Kyiv’s concession in the agreement was acceptance of Gazprom’s condition, to reduce prices not by changing the contract, but by a decision of the Russian government to reduce the export duty on gas. Thus, Moscow may at any time unilaterally increase the price.

During the negotiations, the Ukrainian side was not aiming for an overall renegotiation of the gas contract from 2009, but rather to avoid any agreements which would hamper any subsequent challenge to it during the proceedings in the arbitral tribunal. Thus, from the very beginning, Kyiv had only expected a temporary agreement, declaring that it would be able to survive the winter without Russian gas. The strategic objective remains the overall revision of the gas contract, including the reduction of the gas price and the removal of the ‘take or pay’ formula.

The prospects for Moscow

From the information so far disclosed, it appears that Russia has not made any concessions on the key areas in the trilateral gas negotiations. First, this is confirmed by the method adopted in the document for calculating the price of gas for Ukraine. The final price will not be confirmed – as Kyiv requested – as a result of the revised pricing formula contained in the contract, but rather as a result of the discounts granted by Russia under the government’s provisions to reduce export duty. As mentioned above, in practice, and given the current oil prices, the projected final price of gas is expected to be US$378 per 1000 m³ in the fourth quarter of 2014, and US$365 per 1000 m³ in the first quarter of 2015 years. However, contrary to the initial assumptions, the intergovernmental protocol does not contain any provisions ensuring that the supply price will not exceed US$385 per 1000 m³. Second, from the beginning Russia made the resumption of gas supplies to Ukraine conditional on Naftogaz repaying at least part of the Ukrainian debt for completed deliveries of gas (in June it demanded the repayment of at least US$1.45 billion for deliveries in November-December 2013, and at least US$500 million for deliveries in the period April-June 2014). Finally, the protocol adopted a provision that Naftogaz will pay Gazprom US$1.45 billion before any new supplies are delivered, as well as another US$1.65 billion by the end of 2014, which means a rejection of the reported offer made by the Ukrainian side in October this year to start paying off its debt only after Gazprom resumes deliveries. One concession by Russia was the agreement to recognise the parties’ differences in respect of the calculation and the size of the debt for the deliveries made during November-December 2013 and April-June 2014 in the intergovernmental protocol (as proposed by the European Commission). Thirdly, the use in the protocol of the formulation “Gazprom would forgo invoking the ‘take or pay’ clause of the contract for the period from 1 November 2014 until 21 March 2015” means – from the Russian perspective – a de facto acknowledgment that the clause is an important part of the existing contractual obligations between the parties. In the future, this may make it easier for the Russian side to pursue any claims under the ‘take or pay’ clause for uncollected gas by Naftogaz in 2012-2013 (according to the Russian side, the total value of the debt is over US$18 billion), as well as for the period between January and October 2014.

Although the agreement is generally favourable for Russia, Moscow could derail it and thus bring about a gas crisis this winter and next spring. However, Russia has not decided to do so, probably because it did not want to give the EU any arguments which could prejudice the latter’s important decisions on EU-Russia gas relations (including the OPAL and South Stream pipelines). The deteriorating economic situation in Russia, and the financial situation of Gazprom in particular, could also have played a role.

The EU and the so-called winter package

The conclusion of a temporary winter gas agreement between Russia and Ukraine was reached the day before the end of the previous European Commission’s term of office, and of its efforts to find a solution over several months, primarily by the former Energy Commissioner Günther Oettinger and the EC’s President José Manuel Barroso. Thus, the agreement represents a success for the EC. In addition, the Commission’s involvement in the trilateral gas negotiations with Russia and Ukraine on behalf of the EU, and the development and signing of the agreement, has demonstrated the usefulness of the European Commission as a negotiator in the EU energy policy. However it remains an open question to what extent the negotiated agreement will facilitate the work of the new European Commission, and how much it will be entangled in another political game, if Kyiv or Moscow does not comply with the terms of the settlement.

The agreement’s medium-term consequences for Ukraine and Russia

Ukraine has achieved its main objective in these negotiations, which was to ensure a supply of gas in the winter. Kyiv has realised that, as a result of its negotiations with Gazprom, it will not be able to revise the unfavourable gas contract. For this reason, Kyiv is counting on a favourable settlement at the arbitral tribunal in Stockholm. Naftogaz is expecting an interim decision from the court in November. In addition, Ukraine assumes that its bargaining position against Gazprom will be strengthened, firstly due to the expected decline in domestic consumption due to price increases and a significant reduction of consumption by heavy industry in the Donbas. Secondly, the extension of the reverse gas flow capacities in Slovakia (via the Vojany-Uzhgorod gas pipeline), which the Slovak side has agreed to (on 4 November, the Slovakian pipeline operator Eustream announced the beginning of work to increase the capacity from the current 9.8 bcm to 14.3 bcm, which will be available from the beginning of 2015). However, the question remains open as to whether Naftogaz, which is almost US$10 billion in debt, will be able to accumulate the sum of approximately US$1.7 billion to purchase 4.6 bcm of Russian gas. Most likely, the Ukrainian government will be looking for additional financial assistance from Western institutions.

A gas agreement of this form and content could be to Russia’s tangible legal and political benefit in the medium term. First, Moscow has succeeded once again in forcing Kyiv to confirm that the only legally binding document which regulates Russian-Ukrainian gas relations is the 2009 contract. Gazprom will use it during the proceedings of the Court of Arbitration in Stockholm, in which the Ukrainian party disputes many of the principles laid down in the 2009 contract. Secondly, the end of the negotiations indicates that Moscow has managed to bring the gas talks round primarily to the financial problems of Ukraine, making Gazprom’s political role in bringing about the current situation secondary. After the signing of the intergovernmental protocol, the Russian energy minister said that the agreement was the result of a process initiated by President Vladimir Putin, who in a special letter as early as April had called upon European leaders to hold consultations on Ukraine’s gas problems. By urging the EU to participate financially in resolving the gas crisis (a request a legally binding EU-Ukraine protocol on financial guarantees for Ukraine was made during the final stage of negotiations), Russia foresaw the lack of political will from the EU in this case. Thus, if any problems arise in Kyiv making its  prepayments for new supplies, Russia will be able to put the blame on Kyiv, at the same time treating it as an excuse to withdraw from the gas agreement and return to the use of rhetoric discrediting Ukraine as a partner. New circumstances would provide a basis for raising the political pressure on the EU to make favourable decisions for Russian infrastructure projects (a positive decision for Gazprom on the OPAL pipeline; the withdrawal of EU allegations against the South Stream project).

Forecast

The agreement means that Russian gas supplies to Ukraine will most probably be resumed, and so the gas dispute will be suspended until the end of March 2015. Considering the uncertainties regarding how to implement the adopted arrangements, the poor economic situation of Ukraine and the dynamics of the political conflict between Moscow and Kyiv, we cannot rule out the possibility that the gas ‘ceasefire’ will be violated before the date specified in the protocol. In addition, the parties’ previous statements indicate that hope for a systemic solution to the Ukrainian-Russian gas dispute (involving a change to the legal principles of gas co-operation) is unrealistic in the near future.

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