Naftogaz’s cheap victory: 30-50-year transit exchanged for $2.6bn

The Ukrainian politicians are vying with each other to congratulate their people with Naftogaz’s victory over Gazprom at the Arbitration Institute of the Stockholm Chamber of Commerce. “This is a true victory. Today's decision of the Stockholm arbitration tribunal provided Ukraine with $4.630 billion. These funds will cover the price of gas consumed by us in a very difficult year of 2014. And the budget of NJSC Naftogaz of Ukraine will immediately get $2.560 billion. This is the result of the joint coordinated work of NJSC Naftogaz, government and president," Ukraine’s President Petro Poroshenko said in his video address to his people.

“We’re happy that we won in arbitration on the key issues. It’s an important day for the Ukrainian people and the future of the European markets,” Naftogaz CEO Andriy Kobolyev said.

Gazprom has refused to accept the Stockholm arbiters’ verdict and is going to protect its rights by all possible legal means.

Experts say that the verdict was unexpected and unyielding and may escalate the gas conflicts between Ukraine and Russia. And this is already happening.

“Pump or pay” instead of “take or pay”

Concerning the second transit-related dispute, the Stockholm arbiters have ruled that Gazprom should pay Naftogaz $4.63bn out of claimed $17bn. Since they have refused to revise the transit tariffs, Gazprom will just have to pay penalties for having failed to meet the contract obligations to transmit 110bn c m a year. According to public sources, since 2009, Gazprom has pumped 211bn c m less than it was supposed to and fulfilled its commitments only in 2011. In other words, the Stockholm arbiters have obliged the Russian company to pay for the gas it has failed to pump.

“In fact, they have laid down a new rule in the Russian-Ukrainian contract – ‘pump or pay’ as the contract stipulates no sanctions for low transit. It was an unexpected decision. It runs counter to the arbiters’ verdict to deny Gazprom compensation for Naftogaz’s failure to comply with the ‘take or pay’ rule and to buy no less than 50bn c m a year,” Co-chair of the Energy Strategies Fund Dmitry Marunich said.

"Gazprom expresses its disagreement with this decision by the arbitration institution. Earlier, the same arbiters agreed with Naftogaz’s explanations that the decline in the demand for gas and Naftogaz’s non-compliance with its gas purchase commitments were caused by a slump in the Ukrainian economy. However, the same argument - a decline in gas purchases by European consumers as the main reason for less transit via Ukraine - was not taken into account as far as Gazprom was concerned," the Russian company said in a statement.

Deputy Director of the National Energy Security Fund Alexey Grivach believes that the arbiters were biased: “When considering the ‘take or pay’ dispute, they took Ukraine’s conditions into account and exempted Naftogaz from paying the compensation, while when considering the transit contract, where there is no ‘pump or pay’ obligation, they decided to oblige Gazprom to meet it even though the Russian company has a cheaper market alternative in the form of Nord Stream and even though gas demand in Europe was volatile at the moment. In fact, they used double standards and adjusted their verdict to a certain goal.”

One year of free Russian gas?

The first verdict obliges Naftogaz to repay its $2bn debt for gas supplied in 2013-2014. The second one obliges Gazprom to pay $4.6bn compensation for unsupplied transit gas. That is, Ukraine has gained $2.6bn as a result. “This is exactly as much as Naftogaz would spend if it decided to buy gas from Russia. The arbiters have lowered the maximum level of gas to be bought by Naftogaz from Gazprom annually. Only 80% of this amount is obligatory. That is, if Naftogaz gets the money, it will be able to get free gas for one year. Gazprom will hardly accept this and will certainly dispute the verdict,” Marunich said.

Grivach believes that Gazprom has good chances if it disputes the verdict, but it will be a long process. “Should Naftogaz try to get the money by taking gas from the transit, its conflict with Gazprom will escalate and this may stall the gas contract talks,” the expert said.

Gazprom has taken the first step: it has given Naftogaz back the money it earlier prepaid for gas supplies in March as there is no supplementary agreement that would bring the existing contract into compliance with the Stockholm arbiters’ verdict.

“So, we have to recover the amount paid by the company in full. And it is obvious that the shipments in March won’t start,” Deputy CEO of Gazprom Alexander Medvedev said cited by RBC.

“We have prepaid for Russian gas, fulfilling the award of the Stockholm Tribunal. By refusing to supply this prepaid gas, Gazprom prevents Naftogaz from fulfilling the award regarding the purchase of minimum contract volumes,” Naftogaz CEO Andriy Kobolyev said, adding that the company regards Gazprom’s refusal to supply gas as a contractual violation and non-compliance with the Tribunal’s award. “Naftogaz will demand that Gazprom provides compensation for the damage caused by this violation,” Kobolyev said.

In addition to their decision to reduce the maximum amount to be bought by Naftogaz, the Stockholm arbiters have ruled that since 2014, the gas price has been tied not to the oil price but to the cost of gas at the German NCG Gas Futures. This is a chance for the Ukrainians to buy gas at a price that is lower than the price it pays for reverse gas from Europe or for Gazprom’s gas but instead they will lose transit gas: it will come back to their country and will turn out to be more expensive for their economy.

In Nov 2015, due to the dispute in Stockholm, Naftogaz stopped importing gas from Russia and bought it from re-exporters in Europe.

A cheap victory: 30-50-year transit exchanged for $2.6bn

Some Ukrainians experts are skeptical about Naftogaz’s victory and say that it may turn out to be a Pyrrhic victory.

“The claim to raise the transit tariff has been declined. So, the main goal of the suit – to oblige Gazprom to pay more – has not been achieved. Gazprom will certainly dispute the verdict, so, it is early for Naftogaz to relish its benefits. Instead, it will need more money for lawyers,” head of energy programs at World Economy and International Relations Center Valentin Zemlyansky said.

Independent energy expert Yuri Korolchuk believes that the arbiters’ decision will delay the court proceedings till the expiry date of the Naftogaz-Gazprom contract. “The closer that date – Jan 1, 2020 – the better for Gazprom. The proceedings will come to an end once Gazprom pays the $2.5bn. Until then it will be underway. One more problem is that now Naftogaz will have no more chances to buy cheap gas from Gazprom. In 2018, the average price will certainly be higher than $300 per 1,000 c m. As a result, the Ukrainian Government will not be able to decline the IMF’s request and to keep the current gas tariff unchanged, let alone reducing it,” Korolchuk said on Facebook.

What Ukraine cares for is not direct gas supplies from Russia but the future of the transit after 2020, when the contract with Gazprom expires and when the Russians are planning to launch Turkish Stream and Nord Stream 2. Earlier, CEO of Gazprom Alexey Miller said that after 2020, Gazprom will pump 15bn-30bn c m via Ukraine, which means that the country will earn no more than $750mn a year instead of $3bn earned in 2017.

According to Korolchuk, the Ukrainians have done nothing to talk the Russians around but preferred to appeal to the Stockholm arbiters and may now find themselves in a trap – where their short-term win will turn out to be a long-term loss. “Exchanging a 30-50-year transit for some $2.5bn – this will go down in history as an example of how one can destroy the image of a transit country,” the expert said.

In the meantime, the press service of Naftogaz has said that each Ukrainian gained 5,000 UAH in Stockholm, while had Naftogaz lost, each Ukrainian would have lost 147,000 UAH.

“Should we happen to get the money, I would like to remind Naftogaz that this is enough for it to give us free gas for a whole year or at half a price for two years or at 1/3 of the price for three years. We need specific decisions and specific results. For the time being, the only one enjoying higher bonuses and wages is Naftogaz,” Zemlyansky said.

EADaily’s Energy Bureau