The Third Gas War: EU and US must pay for their “successes” in Ukraine

This is a translation from Russian of an article by Evgenij Pozhidaev, originally found here. The article gives a good overview of the history in Ukrainian-Russain gas relations. It was published on the 25th of April 2014. The article is speed-translated using Google translate and then extensively edited, making it human-readable.

An in-depth analysis of the latest events in this gas war can be read in superb blog post by Lada Ray – Gas Wars: Why Is Ukraine Refusing to Pay for Russian Gas?, “Ukraine wants communism, not capitalism, when it comes to gas” and Lada Ray: Urgent! Gas Wars: Why Is Ukraine Refusing to Pay for Russian Gas? June 14, 2014.

As I was translating this, the Supreme Court of Ukraine stated that Timoshenko is innocent of all gas-related charges against her, effectively legitimizing the gas theft schemes she was involved in.

After the translation of the article, I jotted a few highlights from the latest development.

The Third Gas War: EU and US must pay for their “successes” in Ukraine

So, Russia and Ukraine are on the brink of the next (third) gas war. The gas conflict receded into the background, against the backdrop of the “hot” fighting and repression in the South East, however, it may leave a long-lasting and even larger impact on the Ukrainian political landscape. We begin with a retrospective – especially as gas wars long since became part of the Ukrainian political mythology, the main character of which is a sinister totalitarian neighbour strangling young democracy and not allowing it to achieve great success and genuine European prosperity.

The reality is somewhat different. The History of the Russian-Ukrainian gas relations, is a history where the Ukrainian side always gets what he wants, but the final result is always not to its liking. So, in 2005, Ukraine was bathed in cheap gas. Back then there was a contract that was supposed to operate until 2013, provided for a fixed price of $50 per thousand cubic meters, plus a payment “in kind” for transit, which gave Ukraine 19.7 billion cubic meters at in fact even lower prices.

A second supplier, who successfully uses Russian gas transport system was Turkmenistan, which for lack of other buyers except for Russia and Ukraine sold its gas at $40 – $42. In other words, the claim that Ukraine received gas at $50, is in fact stretch the truth – on average, it was significantly cheaper. In addition “Gazprom” turned a blind eye on re-export. In reality it was a subsidy, which provided the Ukrainian economy is very rapid growth, a positive trade balance and other positive trends in the epoch of late Kuchma. In general, it has been more than generous fee for non-aligned status of Ukraine and relative loyalty – nothing else was required from Ukraine.

However, in 2005 the first Maidan happened. Yushchenko administration made clear pro-Western choice, which was to be paid out of pocket of Moskals that were “robbing” Ukraine. The winning tandem requested the average European price for transit and tore up the contract with “Gazprom”. In response to the monopoly proposed an average European price for gas, which by that time was $160 – $170 per thousand cubic meters. Ukrainian side tried to return to the previous agreements – but it was too late. Negotiations dragged on – and meanwhile, the average European price rose to $220 – $230. Giving maximum and indefinite subsidies to the westernized Kiev power was not in anybody’s plans, and in January 2006 Russia simply turned off the gas flow.

Eventually the price ended up being $98 – still more than the reduced price (for the Baltic States, it was $126), 9 billion cubic meters, which could be bought for payment for transit in monetary equivalent at about 1.5 times the discounted price for it, and the debt of $1.2 billion. That was a turning point in the development of rather quickly growing Ukrainian economy – from this point on the trade balance becomes negative. Nevertheless, it is still subsadies. The problem is that under the agreement the Ukrainian side imposed upon “Gazprom” and the Turkmens, a mediator in the for of the office called “RosUkrEnergo” (RUE), where the Russian gas monopoly indirectly (through “Gazprombank“) owned only 50%. The rest went to Dmitry Firtash and Ivan Fursin. At the same time, behind Firtash’s back was none other as Semyon Mogilevich (one of the leaders of Solntsevskaya gang arrested by FSB in 2008, without being able provide convicting evidence, the U.S. FBI asks for the information leading to his arrest $100.000). As a result, instead of $98, Ukraine received gas all at the same average European price of $230.

Next we delve into the abyss of WikiLeaks, and to be more precise into the report of the then U.S. Ambassador to Ukraine William Taylor‘s meeting with Firtash in 2008. “During the meeting, which lasted two and a half hours, Firtash told the Ambassador that he was a non-public person who has recently increasingly began to dabble in Ukrainian politics. He acknowledged that he “faithfully served” President Yushchenko as an informal adviser during the tense gas negotiations with Russia and political crisis during the “orange revolution” in 2004. He reported that at the request of the President he met Yushchenko three times at his country house last week.” This is confirmed by the former head of the secretariat of Yushchenko Oleg Rybachuk. “I do not know how often they met at the private residence of the president, but as a colleagues told me, he took a very active part in the negotiations.”

“Many a time I started conversations with the president that the gas scheme involving “RosUkrEnergo” is unacceptable. And each time in response Viktor Andreevich remained silent and looked away. According to many years’ experience of communication with him, this reaction I know very well: Yushchenko remains silent if he is not agreeing with your arguments, but can not convincingly argue.” Apparently at about this moment a strong idiosyncrasy about Maidan formed in Moscow, because stealing at the same scale as this team was doing seemed simply impossible.

Yulia Tymoshenko, who just returned to power in 2007, watched the business of her competitors with equal scepticism, and in 2008 RUE got equidistant from Russian gas trade. However, the middle man had by that time accumulated debts of $2.4 billion – and the Kremlin demanded payment, simultaneously placing Firtash and Fursin on the Federal wanted list. Here ends the touching agreement between Miller and Ukrainian “gas goddess” – despite the fact that Yushchenko acknowledged the debt (naturally blaming the Prime minister to it), Tymoshenko refused to pay, saying that it was not the debt of the state, but of RUE.

At the same time Yushchenko tried to return the scheme into the game. “RosUkrEnergo” suggested price of $285 versus $235 from “Naftogaz” (“Gazprom” wanted to receive $250), but Moscow has looked askance at Firtash, preferring a formula – less money, but more transparent scheme. The reaction by President Yushchenko regarding the losses sustained by the billionaire cruel mockery of the crystal honest Ukrainian businessman was tough and unambiguous – he withdrew from the negotiations the delegation of… “Naftogaz”; the latter refused to guarantee transit. Yushchenko and Firtash wanted money at any cost – and the lack of flexibility of the Kremlin has caused their sincere bewilderment.

As a result, on January the 1st, 2009 Russia again stopped gas supplies to Ukraine. “The war”, accompanied by shameless gas extraction by the “Ukrainian partners,” continued until January 19th. In, general, during this remarkable saga, one can watch all Ukrainian classical tricks – blackmail by transit, howls of European officials, statements from Kiev politicians that Russia is robbing Ukraine, appointing non-market prices (in fact constituted the then $320), the requirements of the “technological” gas for free (i.e. gratis) with full gas storage facilities and ultra-patriotic propaganda (Yushchenko: “this is a blackmail of each of you”, “one of the forms to put your existence, stability at greater risk”). The end result was an agreement, according to which gas prices are tied to oil prices (more precisely, on petroleum products – gasoil and fuel oil) with quarterly revisions – i.e. according to common European formula, adopted back in 1960 with the filing of the Dutch government. Obviously, it seemed profitable to the Ukrainian side – in early 2009, of the price per barrel collapsed to $33.67, and Kiev believed it was going to last for a long time. An additional “carrot” was a 20% discount for a year – the southwestern neighbour was given time to improve energy efficiency. Anyway, in 2009, the scheme worked – gas cost Ukraine $228 per thousand cubic meters, almost twice cheaper than less “advanced” users; it de facto meant a subsidy worth about $5 billion. However Firtash-Yushchenko tandem failed to put back into play RosUkrEnergo. Firtash was left profiteering from “Naftogaz” – the latter, while carefully playing a losing game in courts,” presented him in 2010-2012 gas for about $5 billion.

It’s easy to imagine what happened next. Already in the beginning of 2010 it became clear that Kiev traditionally tricked myself – the price of oil topped $80, and gas prices were pulled up after them; in the meantime the term of the discount has expired, and yet in 2009, Ukraine is not at all engaged in improving energy efficiency. As a result, in the first quarter of 2010 the price of gas for Ukraine was $300 – $310 (the average in Europe – $308). When Yanukovych administration came to power, it suddenly realized that Putin-Tymoshenko agreement was “criminal”, and the price – of course, “not a market one”. The result was the Kharkov agreements – in exchange for extension of the Black Sea Fleet stay in Sevastopol until 2042, Kyiv received a 30% discount, which, however, could not exceed $100. In other words, prices returned back to year 2009, continuing to subsidize the Ukrainian economy – that has not prevented Ukrainian politicians to sing a traditional song about the robbery of the free state (thus, Arsenij Yatsenyuk claimed that European countries pay for gas $170 – $220; quite typical case of shameless lies).

By the end of the year the chorus of opposition was joint by the sitting power – the prices rose to $256.7 per thousand cubic meters, and Yanukovych administration again suddenly realized that it signed a contract which is “non market priced”. Kiev began to seek additional discounts – but Moscow has managed to sort out what kind of bird this “protege of Donetsk” is. Kremlin was not going to reduce the prices compared to the average European, only to see further movement towards Euro-shljahta an not keeping the “pro-Russian” promises, so the contract was not revised.

Since then, the Kiev authorities had three main activities:
a) expensive and pointless projects to reduce gas dependence on Russia
b) attempts to finally obtain discounts
c) agitation and propaganda – so that the vast majority of Ukrainians believe that they get “the most expensive gas in Europe.”

Let us consider the last point in more detail. Ex-Prime Minister Mykola Azarov was the one starting the saga of “the most expensive gas” by regularly playing this thesis for several years from the end of 2010. As an example, a quote of 2011: “Ukraine receives gas from the Tymoshenko’ formula considerably more expensive than Germany receives its gas, much more expensive than it is received by Poland. Is that normal? Does that fit into a strategic partnership? And by and large, Russia will have agree with us.” In reality, at the time of pronouncing this perturbed rants, Germany received gas at $355, Poland, Czech Republic and Slovakia – for $340 – $360, Ukraine – to $295. Azarov, to put it mildly, was engaged in manipulation – “forgetting” about the discount and the transport component and pointing to the base price of gas, which existed only on paper. Over time it has become a common practice in the Ukrainian establishment – thus, speaking in the early 2013th, Deputy Minister of Mines and Energy Vladimir Makuha dutifully alerted the world that in 2012 Ukraine bought gas at $416 – $426, and in the first quarter of next year – for $432. It’s hardly necessary to specify that such prices for Ukraine have never existed. Such was the general style of negotiation and propaganda attacks, which expectedly did not lead to any results over the span of three years.

Anyway, the Russian Prime Minister Dmitry Medvedev is absolutely right: the history of gas relations between Russia and Ukraine – is the story of endless subsidies of the Ukrainian economy, gradually reduced by a Ukrainian initiative, through parasitism of local “elites”, which actually put a tribute on Russian Federation, and mortal offences taken by Kiev over whether that subsidies are inadequate, and parasitism which went by without enough punishment. Of course, this was conducted against the backdrop of the shouts of patriotic Ukrainian public, which was strongly offended by “Moskal’s” for the fact that they do not let Firtash, Mogilevich, Tymoshenko and others to profit on that very same public.

What came next is known well enough – Ukrainian collapsing economy still got gas at $268 per thousand cubic meters (the highest price in 2013 was $398) and credit to pay for the accumulated gas debt. For comparison – the average price for Italy in 2013 was $418, Germany – $479 France – $555. Relatively cheap gas was supplied to Turkey, with which “Gazprom” signed a 25-year contract ($388) and Britain ($330), where the gas monopoly, obviously, made a bid to actively expand its market share.

In other words, by any standards, Ukraine received ultra-subsidised price – but, of course, Moscow did see even a shade of gratitude (conscious Ukrainian patriots immediately concluded that the $268 – this is a market, and the previous price was overstated). These rates remained also after the February coup – Russia dutifully supplied gas throughout the first quarter, and continues to deliver it now. Meanwhile, Kiev regime completely stopped the payments from the second half of February – even though only half of the provided loan was used for the payment. As a result, only in March Ukraine’s debt increased by $550 million, reaching $2.2 billion. We were actually pronsoting and are still sponsoring a regime that is hostile towards Russia.

On April the 1st, “Gazprom” announced the cancellation of “Yanukovych discounts” and price increases to $ 385.5 – officially because of default on repayment of principal and lack of payment of the current supply. On April the 3rd, Kharkov agreements were denounced and the price rose to $485. However, as explained by sources in Moscow, it was a preventive measure – price was slated to actually come closer to $500 in case of possible tricks from the Ukrainian side. On April the 7th came the deadline for March payments. In other words, the “cold” phase of the gas war began two weeks ago.

Meanwhile, the reaction of Kiev became less and less adequate. On April the 4th Ukrainian profile Minister Yuriy Prodan said that the blame for not paying for gas lay on… Russia. “There were commitments agreement. Among these agreements in 2013 were also the obligations of the Russian side on granting Ukraine a loan of $15 billion, you know, the first part of the loan in December 2013 in the amount of $3 billion has been paid and has been received by Ukraine. Second part of the obligations matures in February 2014. The Russian side also pledged to give Ukraine a loan of $2 billion. Moreover, the obligations on the part of Ukraine – that Ukraine will pay the money as the corresponding payments for gas. Such were the arrangements. We seek confirmation of these arrangements formally in writing.” Thus Ukraine insisted on maintaining the same gas prices ($268). In other words, Moscow was offered to keep the massive subsidies and loans to new Ukrainian regime. The problem is that Russian Federation does not have and never had such obligation to credit [the new regime], linked to the gas contract.

On April the 5th Prodan still maintained that he’ll ensure the transit of gas to Europe regardless of the development of the “dialogue” with Russia, but then Ukraine’s position began to quickly evolve. Already on April the 8th, the Minister said that a price of $500 will be put transit in jeopardy and directly called the actions of the Russian Federation for economic war. The next day, the head of the National Bank of Ukraine Stepan Kubiv surprised financiers with a fresh discovery in the field of monetary policy, saying that Ukraine has “returned” the three billion Russian loan, paying it for the gas. First of all, what is notable here, is an alternative logic, according to which a loan spent is considered to be a loan returned. Second, there are the outright lies – only $1.6 billion were used to pay for the gas, while $1.4 billion disappeared in an unknown direction (obviously, this explains the sharp decline in the reduction of the gold reserves of the National Bank of Ukraine (NBU)). On the 9th the Ministry of Energy put its threats in effect, stopping pumping gas into underground storage (UGS) – something that virtually guaranteed transit disruptions. Kiev regime actually told Moscow to support them by resorting to the traditional transit blackmail. At the same time during a meeting in the Kremlin, it was agreed that Ukraine should be translated into an advance payment – that officially was possible to do from April the 17th; while the reason for disconnection of gas appeared from the 1st of May. Besides, the EU and the United States were offered to provide for “their bastards” themselves. Putin: “As you know, our partners in Europe recognize the legitimacy of the current Kiev authorities, but do nothing to support Ukraine. Not with one dollar, nor with one euro.”

Next, the following happened. Almost simultaneously the head of “Naftogaz” Andrew Kobolev directly linked the possibility of “repayment”, with retention of the old price. later a time frame was designated, within which there must be reached a new agreement – according to the local Department of Energy, in the event of disconnection of gas, Ukraine will be able to provide transit for three months from existing reserves.

Position of the EU and the IMF was more constructive. EU Energy Commissioner Guenther Oettinger: “There is no reason to panic. I prepare a decision by which Ukraine is to pay to “Gazprom” from the package of credits allocated by the IMF, the ECB and the World Bank.” Later, the European Union issued two more conflicting signal. On the one hand, European Commission President Jose Manuel Barroso spoke out against the introduction of prepayment and actually laid on “Gazprom” the responsibility for providing transit. On the other, Oettinger reiterated his statement on the need to help Ukraine pay $2.2 billion gas debt. A similar statement was made by the head of the IMF’s External Relations Department Jerry Rice.

In parallel Russian Federation finalized the terms of financial assistance to Ukraine, which included constitutional reform, legitimate elections, the deescalation in the East and “legitimization of the situation around the Crimea.”

In other words, by the middle of last week, the situation looked like this. Kiev will not pay – even Turkish minimum (about $400 per thousand cubic meters) will result in a $12 billion. Together with debt payment ($10 billion) for this year, it will eat almost all western aid promises. The problem of the western adventure in Kiev is that it by default assumed that everything was paid for by the Russian Federation – which was pre-assigned to be the guilty side in the Ukrainian crisis. While the EU and Ukraine actually do not have three months to negotiate – in stores contain only 8 billion cubic meters of gas and it’s technologically extremely difficult to take it out completely. Ukraine in fact has no alternative sources of gas. With gas imports of about 30 billion cubic meters per year, the maximum possible amount of gas that can be supplied from Europe is 12 billion cubic meters. Slovakia accounting for 10 of them, and is not entirely positive to the prospect of doing reverse deliveries. The problem is that the new Ukrainian authorities are not ready to invest in the construction of appropriate infrastructure, nor guarantee its load. As a result, Slovakia without the consent of “Gazprom”, is ready to deliver only 3.2 billion cubic meters. At the same time the supply of 1 billion cubic meters of reverse deliveries in the past year allowed Ukraine to save only $34 million. If the situation is replayed, the savings will be penny-worth this year as well.

Even more absurd is the idea of ​​importing liquefied natural gas – Turkey has quite clearly stated that it will not allow LNGs to pass through the Bosporus. While LNG is extremely expensive – thus the gas from Qatar on 40-50% more expensive than Russian. In other words, Ukraine does not have any chance to get away from gas dependence.

Equally absurd is the rhetoric of the West and the Ukrainian establishment, threatening RF with isolation from the European gas market in the case of “incorrect” behaviour of Moscow. Consider the situation in more detail. The share of “Gazprom” exports to Europe in 2013 – 139.92 billion cubic meters per year. It is necessary to replace this volume. There are some possible sources of supply to Europe. The most publicized – the U.S., which are ready to start exporting LNG (their production is growing fast due to shale technologies), followed by Iran, Azerbaijan, Algeria and Qatar. Norway and the Netherlands are hopeless by default – Dutch reduce their production, exacerbating the shortage of its own gas to Europe, while Norwegians are simply not in a position to dramatically increase theirs, and after 2020 it will start to decline rapidly. At the same time, gas production in importing countries has been steadily declining (as in Germany it fell from 16.9 billion cubic meters in 2000 to 10.6 in 2011), and consumption is growing, in part due to “wrapping up” of nuclear energy.

So, consider the alternatives. Let’s start with Iran – the situation with them is extremely simple. Iran imposed an embargo on the sale of oil and gas to the EU at the beginning of 2013 in response to “hostile policy toward Iran” (in other words, sanctions). The gesture was largely symbolic, however, the same argument was repeated at the beginning of this year, when it was decided to lift the sanctions – but in a modified version. Now the reason for the embargo was a hostile policy towards Iran and… Russia. In parallel the Russian Federation and the Islamic Republic of Iran made an unprecedented barter deal on oil supplies to Russia, bypassing the dollar settlements. In other words, firstly, the potential competitors get along well with each other. Secondly, the basic amounts of Iranian gas will be produced by Chinese companies and will go to China. The West cannot hope to sick Tehran and Moscow against each other – rather they’ll peacefully divide the European market. Further, Qatar at the moment just does not have the surplus gas (all the world supply of LNG – 120 billion cubic meters), and its exports mainly in Asia – at a very impressive price. As for Azerbaijan, the limit of its possibilities – about 4% of the European market. Algeria has only 4 trillion. cubic meters of gas reserves (about a seven-year consumption in Ukraine, or less than five years for Germany), and the existing pipeline network is able to provide only 47% of gas consumption in Spain.

In other words, the only chance in Europe – is the U.S., whose export potential is estimated at 200 billion cubic meters, while domestic prices are $135 U.S. per thousand cubic meters. However, there are a few ugly strokes in this positive picture that mess it up. In the short term, the massive gas export from the United States is not possible – currently they are a pure net importer (60 billion cubic meters from Canada), and they are not expected to reach self-sufficiency until 2017. Start of exports also does not promise Europeans a sea of ​​cheap gas. U.S. Secretary of Energy Ernest Moniz in an interview with Czech television: “If we take the present value of gas in the U.S. market and add to this the costs of liquefaction, transportation, de-liquefaction, and possibly even for the construction of any pipeline, the price – if the gas will be delivered to the Czech Republic – will be about the same as you are paying now.” Meanwhile, the operations by minister with domestic U.S. prices sin with strong craftiness – they are radically underestimated. Shale gas production is now unprofitable. Thus, Royal Dutch Shell has written off $ 2.2 billion due to losses associated with the development of shale gas. A year earlier, shale project turned a 5 billion loss for BHP Billiton.

An increase of domestic gas prices in the U.S. is a matter of time, and it will be significant. The States will in the very near future be faced with a reduction in oil production and closure of a long series of nuclear reactors at their plants – and the “dropped out” energy will have to replaced with something. One should take into account the fact that the gas reserves, as shown by recent studies, have been overstated (by 7.5%). So: U.S. obviously will never be able to compete with Russia on the European gas market.

In other words, when making a choice between a gas war and subsidising of and anti-Russian regime in Kiev in general, and the bounty hunter for Russian citizens – Mr. Kolomoyskogo in particular, the Russian Federation should choose the gas war. The entire history of Russian-Ukrainian relations shows that subsidies to Kiev practically never brings political dividends – good intentions are nothing against a well-run propaganda machine. The EU and the U.S. should pay for their “successes” – and so dearly that they are not tempted to repeat them.

This concludes the original article. After it was written, a series of 8 rounds of negotiations followed, during which EU acted as a mediator and suggested the price of $385 per thousand cubic meters. The Ukrainian side sabotaged the negotiations in any way they could, on one occasion leaving the site and driving off in an unknown direction, presumably to receive further instructions from their Washington masters.

After all the efforts, Ukraine finally declined the EU-suggested price and refusing to pay back the debt, forcing Russia to file a law suite with the international court of appeals in Stockholm. Russian Federation was also forced to stop gas deliveries also this time – from the 16th of June Ukraine’s regime lives on stolen time.

In this regard, it is interesting to note a leaked telephone conversation between two high-ranking Ukrainian officials. It concerned the money provided by the U.S. to buy military equipment. U.S. demanded accountability, while the Ukrainians have already offshored half of the amount and were surprised that accountability was required. One of the officials said that they can use the money from the IMF loan that was earmarked for gas debt down-payment to make weapons purchases, and will simply “handle” Gazprom’s Miller, not paying for the gas.