Wednesday, 30 January 2013

Russia slaps hefty natural gas bill on Ukraine

In a centuries-old battle between Ukraine and Russia, the latest instalment of the drama sees a whopping $NZ7 billion fine issued recently to Kiev for infringing a natural gas import agreement between the two countries.

$NZ7 billion is a lot of money. It would a hefty price tag to receive on anyone’s energy bill. There are some shocking stories about incredible gas bills, which are usually paid if the gas was actually burned in the end. But what if the bill was presented for natural gas never used at all?

This is the astounding situation Ukraine finds itself in this week. Russian energy giant Gazprom presented Ukrainian energy firm Naftogaz with the multi-billion dollar bill for gas it claims was bought, but never burned by Ukraine in the 2012 calendar year.

According to Gazprom, Ukraine was committed to import the gas last year under a minimum “take-or-pay” agreement in which at least 80 percent of ordered gas must be imported. Last year Ukraine gas imports were expected to close at around 42 billion cubic metres (bcm). However, although Ukraine currently buys the gas at an exorbitant $430 per 1000 cubic meters – way above market price – it only managed to import 33 bcm in 2012 instead.

Kiev responded to the enormous bill by suggesting it look elsewhere to fulfil the country’s natural gas requirements. Gazprom is a state-owned energy firm and a favourite tool for Moscow. This isn’t the first time Russia has used energy exports as an effective political lever in its near-abroad.

Given the bill’s price tag, officials in Kiev are understandably motivated to increase energy diversity to nullify Moscow’s influence over the former Soviet republic.

Of course, the steep gas bill did not arrive in Kiev’s mailbox in a political vacuum. A few days prior Kiev announced a deal was successfully signed with Royal Dutch Shell for shale gas exploration in Ukraine.  
      
This deal is reportedly worth $10 billion and will be the biggest production-sharing agreement yet to tap the vast shale gas deposits in Europe. Industry estimates predict Ukraine holds a gigantic 1.2 trillion cubic meters of natural gas, although actual production will be still several years away.

It is important to remember the $10 billion figure as Ukraine’s potential income from shale gas exploration is only a top-end figure. It is certainly not a guaranteed result of the deal and Ukraine may find itself in a less-than-optimal position if the reserves do not prove significant. Shale gas reserve estimates are known to be imprecise at best, and previous drilling companies have pulled out of similar deals citing poor results from test wells.

But with the Shell contract signed, Kiev could unlatch itself from Gazprom’s grasp and, assuming the gas reserves are all there as promised, may become a major exporter of natural gas to Europe in its own right once Shell begins producing gas.

For Russia, continuing reliance on its natural gas exports in Ukraine is extremely important. Russia receives a great deal of cash from these exports, which keep rising in lock-step with energy market prices.

Kiev’s bold energy moves with Shell must avoid a repeat of the 2009 fiasco when a rancid deal brokered by former Ukrainian Prime Minister Yulia Timoshenko restarted delivery of strangled natural gas supplies from Russia.

Those cutoffs seriously affected Europe. Ms Timoshenko was under pressure to end the strangulation of energy and make a quick deal with Moscow. The former Prime Minister is being used as a pawn to discredit the gas deal between Kiev and Moscow and now languished in prison for her troubles.

Russia’s designs on regaining some semblance of implicit control over its former Soviet republic were likely the motivating factor in halting the gas supplies in 2009. Gazprom and Moscow backed Kiev into a corner to secure some of the most exorbitant gas prices in Europe, while including the now-relevant ‘take-or-pay’ clause in a dark corner of the hastily signed agreement.

Ukraine struggled to meet the gas payments with an already stretched budget. The $7 billion bill was sent from Moscow when Kiev decided to cut its natural gas imports from 42 bcm to 33 bcm last year, contravening the agreement signed in 2009.

The price of natural gas has only increased in the years since with only a few discounts conveniently negotiated to secure basing rights for Russian ships at the Crimean port of Sevastopol. Moscow is potentially looking to concede Kiev into another Gazprom-friendly agreement this year by issuing the hefty bill.

Yet the situation today is not the same as in 2009. The gas cut-offs opened the eyes not just of Kiev, but of many other European countries as well. Russia, it was realised, held a long arm over the energy dependencies of many European nations. In response, alternate energy avenues have been explored and a significant amount of gas supplies is set to diversify Western Europe away from Russian natural gas in the coming years.

Ukraine’s deal with Shell in this case will assist in helping other Europeans make the necessary moves to develop other deposits of shale gas.

The controversial hydraulic ‘fracking’ technology has held back development for fears if possible environmental damages. It is widely hoped the Shell deal will herald a new revolution in shale gas exploration in Europe, similar to the experiences of both Australia and the United States in the past decade.

In the short term, Ukraine will continue to import the majority of its natural gas from Russia, despite an upfront $400 million investment from Shell. But in the long term, Ukraine, and much of Europe, will come to rely less on Russian energy as new fields are tapped.

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