Ukraine is about to lose its precious gas-transit business as its state-run gas giant struggles to function as the puppet of multiple geopolitical players and agendas, and it’s not likely to get any more help from Washington—nor Europe.
New pipelines could mean the end of Ukraine’s lucrative gas transit business, warns Ukrainian state-run Naftogaz head Andriy Kobolev, and the country stands to lose between US$800 million and US$1 billion in annual revenues, with the company’s profits for the last year coming in at $805 million.
The existing agreement between Russia and Ukraine for gas transit expires in 2019, but the Turkish Stream and Nord Stream 2 pipeline projects may ensure that Russia gives up on Ukraine entirely, and hedges its bets with new European partners.
The Pipeline Threat
The Turkish Stream and Nord Stream 2 pipelines will bypass Ukraine to bring Russian gas to Europe.
Russian state-run Gazprom is the largest exporter of gas to Europe. At the beginning of 2017, the company noted record exports of 615 million cubic meters of gas per day. For 2016, Gazprom exported 12 percent more gas to Europe than it did in 2015—figures that indicate Europe’s gas dependence on Russia is only increasing.
The Nord Stream 2 pipeline is financed by Gazprom, and like the original Nord Stream, the new version is being built by Gazprom, along with a consortium of Western European energy companies. The group consists of Austria’s OMV, France’s Engie, Germany’s Uniper and Wintershall, and Shell. Gazprom has a 51-percent stake in the project.
Once operational—which is scheduled for 2019—the pipeline will carry 55 billion cubic meters (1.9 trillion cubic feet) of gas a year to Germany.
Nord Stream 2 involves the construction of a gas pipeline under the Baltic Sea that would connect Russia with Germany, and then distribute gas to European Union countries. The entire project is projected to cost between US$8 billion and US$11 billion.
The looming pipelines have prompted many—not just Kobolev--to ask what’s next for Ukraine, which has for so long relied on this gas transit income.
The Turkish Stream pipeline is also led by Russian Gazprom. This pipeline will run through the Black Sea, connecting Russia and Turkey. It is estimated that the total cost of the project will be upwards of US$13 billion.
Announcing the inter-governmental agreement for the construction of the pipeline in October, Russian President Vladimir Putin heralded it as a cooperation-broadening project that will provide discounted gas to Turkey. Related: Oil Production Here Is Declining Faster Than Anywhere On Earth
The Turkish Stream project agreement envisioned the construction of two pipeline branches, each with a capacity of 15.75 billion cubic meters, with the construction of both scheduled to be finished by December 2019.
A Self-Fulfilling Prophecy?
In an Oxford Institute for Energy Studies (OIES) paper, senior research fellow Thierry Bros notes that transit through Ukraine and resulting revenue has already fallen. He also suggests that Ukraine’s own policy of increasing transit tariffs may have boosted the development of the very pipelines that are now threatening its economic stability.
“It would now seem that Naftogaz may also be forced to adapt to new realities and to react to competitive pressure by reviewing its transit fee strategy, potentially even reducing its transit fees. Indeed, given there appears to be no realistic chance left for increased transit revenue, Ukraine’s choices appear limited if it wants to retain part of the $1bn/y transit fee that does remain.”
Now that 2019 is looming and Ukraine has no real backup plan for what Naftogaz’s role will be in providing the state with revenues when gas transit is no longer the go-to, economic stability comes into question in a very real way. But Ukraine’s problems go beyond gas transit, notes Roman Storozhev, president of the Association of Subsoil Users of Ukraine.
“Naftogaz has a monopoly position on the Ukrainian gas market because of the impact on its subsidiaries Ukrtransgaz, Ukrtransnafta, and Ukrgazvydobuvannia. Naftogaz does everything. And it doesn’t do it well,” Storozhev noted recently.
Geopolitical Puppets and Proxy Wars
Throughout, Naftogaz has been a political and geopolitical puppet--a centerpiece in the proxy battle between Russia and the U.S., and some of the fallout from that battle is now being playing out in Washington as the U.S. prepares to inaugurate its next president.
As Forbes so succinctly puts it: “It [Naftogaz] is always in the crosshairs of the Russians; its funded by the World Bank and the European Bank for Reconstruction and Development (EBRD). Everyone’s favorite hedge fund villain, George Soros, who has been involved in Eastern Europe for over 25 years and is a major Obama and Clinton donor, has a hand in Naftogaz.”
While Naftogaz is Ukraine’s revenue lifeline, this is also about Russia’s annexation of the Ukrainian Crimea in 2014, and about what will happen to the EU once these two new pipelines cement dependence on Russian gas. But Europe has a hard time breaking free from this noose that it continues to tighten of its own accord.
Germany’s official stance is that its future needs Nord Stream 2, but the coalition partners in the government don’t necessarily see eye to eye on this.
Norbert Röttgen, a Christian Democrat who chairs the German parliament’s foreign affairs committee, and Reinhard Bütikofer, a senior German Green in the European Parliament and co-chair of the European Green Party, want the project scrapped, both for moral and political reasons.
The Social Democratic Party--Chancellor Merkel’s coalition partner--is insistent that Germany needs this pipeline, and in that they have strong support from former German chancellor Gerhard Schroder, who was recently appointed chairman of the board of Nord Stream 2.
But even Merkel is not sold on the idea, leading to the emergence of an unlikely coalition between the conservative Christian Democrats and the opposition Greens. Related: $25 Trillion Investment Needed To Meet Future Oil Demand
They take issue with the economics more than anything. As Carnegie Europe points out: “Why [...] should a group of European energy companies finance a Russian project and import Russian gas that in effect pays for President Vladimir Putin’s military campaign in Syria and his meddling in Ukraine?”
Back to Washington …
In DC, this was the hot topic of discussion at former Exxon Mobil chief Rex Tillerson’s confirmation hearing before the Senate Foreign Relations Committee last week. During the hearings, Senator Marco Rubio (R-Fla.) criticized Obama for not acting more aggressively in the face of Russia’s annexation of the Crimea, and he also indicated that he doesn’t expect Tillerson--who many perceive has friendly ties to the Kremlin--to act aggressively, either.
Rubio described Putin as a “war criminal”, referring to Russia’s actions in Ukraine and Syria, but Tillerson refused to strap this on, saying he wouldn’t categorize Putin as such, and would need more information before making such a charge.
Instead, Tillerson said he recognized that Russia “poses a danger.”
“It invaded Ukraine including Crimea and violated the laws of war. But it’s an absence of American leadership that left this door open…That was a taking of territory that was not theirs…. The real question is about the response,” said Tillerson in his confirmation hearing, falling short of the decisive answer that some were hoping for, but going further than many had predicted.
That unknown should lead Kiev to devise a plan of its own and set it in motion—a plan that makes sense in a new world where its gas transit isn’t as necessary as it once was. It’s time for Naftogaz to come of age and drag itself out from under its geopolitical puppet masters.
By Damir Kaletovic for Oilprice.com
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