For the short term at least, Ukrainians and Europeans won't have to worry about shelling out more to heat their homes this winter. An eleventh-hour extension to an energy transit agreement will guarantee the continued flow of natural gas from Russia to Europe through Ukraine over the next five years, but there is little indication that the current deal will presage longer-term cooperation between Moscow and Kyiv. Indeed, lingering distrust between the two capitals will lead Ukraine down the path of producing its own natural gas to achieve self-sufficiency in the longer term, while Russia will strive to shift shipments to pipelines in the Baltic and Black seas that don't present as much of a political nuisance. Ultimately, the emergence of other transit routes will reduce the calming effect that natural gas transit deals have had on the two countries' larger political disputes over hot-button issues like Crimea, eastern Ukraine and more.
Russia supplies nearly half of Europe's natural gas, and Ukraine's pipeline infrastructure plays a key role. But the construction of new pipeline infrastructure in the Baltic and Black seas will allow Russia to reduce its dependence on Ukrainian infrastructure.
The Road to an Agreement
At the outset of the most recent talks, Russia proposed a one-year deal. At the same time, Russia also demanded that Ukraine's Naftogaz drop all litigation it had filed against Gazprom for allegedly pumping less than the 110 billion cubic meters (bcm) per year it was required to ship during the previous contract from 2009 to 2019. Ukraine, by contrast, wanted a 10-year agreement that would have provided Kyiv with a guaranteed income from transit fees over a long period in which it hoped to further develop its own natural gas production or alternative import sources. At the same time, Ukraine, as well as the European Union, had proposed a minimum transit of 60 bcm per year, with an additional capacity for 30 bcm.
After exhaustive negotiations, representatives of Russia's Gazprom and Ukraine's Naftogaz finally reached a preliminary agreement for a five-year extension to their new gas transit contract on Dec. 19, just 12 days before the present deal was set to expire.
Gazprom also committed to paying $2.9 billion that a Stockholm court earlier ordered it to pay Naftogaz as compensation after volumes dropped to less than 90 bcm per year, particularly as a result of the Euromaidan uprising. Naftogaz, in exchange, agreed to stop pursuing additional lawsuits related to transit in which it had demanded a total of $13 billion.
Both Ukraine and Russia ended up making concessions relative to their initial demands in order to pragmatically sustain gas flows.
And in terms of yearly volumes, the new agreement envisions a progressive reduction in Russia's use of Ukrainian infrastructure from the current volume of 90 bcm to 65 bcm next year and just 40 bcm in 2021. As a result, Ukraine would normally collect less revenue, just as the costs of maintaining the aging infrastructure will rise. But under the new deal, Naftogaz and Gazprom have reportedly fixed the transit fees over the next five years at a higher level to allow Ukraine to sustain its roughly $3 billion in revenue even though volumes could drop by more than half.
The extension is of great economic importance to both Russia and Ukraine, as the lack of a deal would have physically prevented Russia from pumping enough natural gas to European markets to meet demand, while Kyiv would not have been able to reap transit fees. Both countries ended up making concessions relative to their initial demands in order to pragmatically sustain gas flows. From Ukraine's perspective, the new agreement will give Kyiv some level of reliability and generate revenue of at least $15 billion — $2 billion more than it would have gained if Naftogaz had won the lawsuits it originally filed against Gazprom. While the country might not have achieved as much as it could if it had stood its ground in negotiations, it evidently chose to sacrifice revenue for more certainty.
Toward New Routes
The agreement, however, does not herald a long future of Russian-Ukrainian energy ties. The importance of Ukraine as a transit country lies within the broader context of the natural gas pipelines that connect Russia and European markets. Next year, Russia hopes to bring both TurkStream and Nord Stream 2 online to increase its total export capacity to Europe and develop more alternatives to Ukraine. Since the breakdown of relations between Kyiv and Moscow in 2014, Russia has considered Ukraine an unreliable transit route, and numerous legal and political conflicts between the two have complicated their relationship.
For one, Gazprom has chosen to honor the $2.9 billion compensation verdict, but Naftogaz is still exposing itself by dropping litigation in the name of a new deal, as it has accepted the risk that Russia may choose not to abide by their new agreement in years ahead — something that could cost the Ukrainian company revenues down the road. (Naftogaz, nonetheless, will continue its efforts to recover over $5 billion from Russia it says it incurred when Moscow annexed Crimea in 2014.)
While the latest agreement may succeed in averting the disruption of natural gas flows to Europe, the devil in the details does portend a radical shift in the infrastructure that brings Russian gas to Europe.
As it is, Ukraine ceased to directly consume Russian natural gas in 2015 (it still depends on Russia for about 10 bcm a year, or a third of its consumption, through so-called reverse flows of Russian natural gas that Moscow sells to other European countries, which then sell it on to Ukraine) and intends to develop its own resources to the extent that it would no longer be import-dependent. While Ukraine is unable to do this for now — and has failed to meet several targets in developing such abilities — the country's long-term goals of self-sufficiency would make its transit infrastructure a viable political tool that Kyiv could use to disrupt Moscow's access to European markets without risking its own supply.
While the latest agreement may succeed in averting the disruption of natural gas flows to Europe, the devil in the details does portend a radical shift in the infrastructure that brings Russian gas to Europe. Despite U.S. attempts to sanction the construction of Nord Stream 2 and TurkStream, Russia will bring both of these pipeline projects online in 2020, allowing it to begin shipping natural gas to Europe through routes it considers more reliable. How quickly that happens will depend on Gazprom's delivery contracts with customers in Europe, as such contracts often specify the point of delivery. Whatever the case, the writing is on the wall for Ukraine's status as a major transit corridor between Russia and Europe, as cost and geopolitical risk are likely to drive Moscow to ship more natural gas to its European customers through alternate routes in the year to come. And that reality could have profound effects on their political problems; with the need to cooperate to ship natural gas to Europe diminishing, there will be one fewer factor inhibiting their geopolitical quarrel.