Ukraine gas deal loosens Russia’s grip

A landmark “unconventional” gas deal Ukraine signed with Royal Dutch Shell on Thursday in Davos demonstrates just how determined the former Soviet republic is to break its dependence on imported Russian fuel.

Ukrainian officials say the potentially $10bn-plus project is a big step in a broader effort to boost domestic production, diversify supply sources and make its gas-guzzling heavy industry more energy efficient.

The Shell deal in itself poses a limited short-term threat to Russia’s Gazprom, since, even if as successful as Ukraine hopes, it will take some years to begin producing. But, longer term, it may force the Russian gas monopoly to rethink relations with its biggest foreign customer.

Gazprom may in part have brought this shift upon itself. It has twice cut off gas to Ukraine since 2006 amid disputes over prices and unpaid bills. In that time, it jacked up gas prices to more than $500 per thousand cubic metres – before a $100 discount Kiev negotiated in 2010 in return for extending Moscow’s lease on the Crimean naval port of Sevastopol.

That is a higher gross price than Gazprom charges many more distant west European clients. Ukraine’s latest 2009 contract with Gazprom is the official reason Yulia Tymoshenko, the former prime minister, is in jail – after prosecutors charged that she abused her powers by agreeing a deal at an excessive price.

So one of Europe’s most energy-intensive economies has had to change, to reduce its $13bn annual Russian gas bill. Last year Russian gas imports into Ukraine fell 25 per cent year-on-year to 33bn cubic metres. Total domestic demand was down 8 per cent.

Ukraine’s reduced needs are partly caused by recession and slow growth since the 2008 financial crisis. But Dennis Sakva, energy analyst at Kiev-based investment bank Dragon Capital, said Ukraine’s vast metallurgical industry and electricity generators had cut demand by switching from gas to coal. Ukraine also reduced losses and the gas it uses to run pumping stations in its large gas pipeline system by 37 per cent last year, he added.

Eduard Stavytsky, the energy minister, told the Financial Times: “By increasing domestic production and boosting efficiency, we can this year further reduce imports.”

That could, in theory, make Ukraine liable for heavy fines under a minimum “take or pay” clause in its 2009 contract. But Gazprom appears reluctant to enforce these penalties. Sergei Kupriyanov, Gazprom’s spokesman, confirmed on Thursday that Ukraine was already importing less than minimum contracted volumes but said enigmatically that Gazprom was not demanding fines “because we need to set realistically attainable goals”.

Ukraine has potentially enough untapped gas to reduce future imports to a minimum. Estimated to hold Europe’s third-largest shale gas reserves, it is bringing in international energy majors in hopes of replicating the North American shale gas boom of the past decade.

US-based Chevron won a tender last year to explore for shale gas in western Ukraine. ExxonMobil and Shell were chosen to explore off Ukraine’s Black Sea coast.

“I am confident that these projects will produce enough gas to allow Ukraine . . . to completely cover domestic gas demand within 10 years,” Mr Stavytsky said.

Any reduction in imports from Gazprom over time could have a significant impact on the Russian monopoly.

Ukraine’s consumption decline in 2012 “certainly has to cause Russia to assume that it will not sell the amount of gas it expected to sell to Ukraine in the coming few years”, said Simon Pirani, senior research fellow at the Oxford Institute for Energy Studies.

Gazprom’s nearly 40bcm exports to Ukraine in 2011 compared with 150bcm to the entire European market farther west.. More than half its 503bcm total sales were to Russia itself – at much lower prices.

Gazprom has already been forced to negotiate lower prices in its long-term contracts to several big west European customers as prices for “spot”, or market-traded, gas have fallen sharply thanks to a flood of cheap liquefied natural gas cargoes from other sources into Europe. The European Commission is also conducting an antitrust probe into whether Gazprom is abusing its dominant position in central and east European markets, which Moscow denies.

Ukraine, meanwhile, is making other efforts to diversify sources. Mr Stavytsky said it would this year begin building three coal gasification plants, financed by a $3.7bn Chinese credit line, and an liquefied natural gas terminal capable of importing at least 5bcm annually.

Greater energy independence could also potentially help Kiev break free of Moscow’s political orbit, as gas has been a central bargaining tool for Russia. President Vladimir Putin has offered lower gas prices as part of efforts to persuade Ukraine to join a customs union Russia is creating with Belarus and Kazakhstan.

Gazprom’s Mr Kupriyanov played down any threat, however. “We don’t understand these arguments that we could lose [this] big market,” he said.