You're reading: Cheap Russian gas proves to be both asset, liability

Before December, the Ukrainian government only could dream of having a $268.50 price tag for 1,000 cubic meters of Russian natural gas, its main supplier of the blue fuel.

Paying more than $400 at the time, Ukraine in December saw the dream come true when President Viktor Yanukovych finalized the deal in Sochi with his Russian counterpart Vladimir Putin.
But is it really a castle in the air and what strings come attached with it? Analysts have serious difficulties answering this question because any deal with Russia has heavy political overtones. The clearest aspect is that Ukraine’s neighbor and former ruler gets to review the deal on a quarterly basis and could be canceled should the political situation change to Russia’s disliking. Although the gas price discount will alleviate short-term fiscal constraints, its long-term impact on the economy depends on the quality of investment decisions the government makes with the money spared.
In particular, on Dec. 17 Yanukovych and Putin signed an annex to the 2009 gas contract, implying a substantial gas price reduction, although exact terms of this agreement have not been disclosed.
According to the 2009 deal, which eliminated the RosUkrEnergo intermediary controlled by Russia’s Gazprom and Ukrainian billionaire Dmytro Firtash, the price of gas rose over time, eventually reaching more than $400 and straining the nation’s budget.
“This recent gas agreement between Russia and Ukraine raises more questions than (it) provides answers, which is a pattern we have seen before,” says Edward Chow, an energy analyst for the Center for Strategic and International Studies in Washington, D.C.
Besides the quarterly gas price review, Naftogaz – Ukraine’s state-owned oil and gas conglomerate – told the Kyiv Post that it cannot re-export the cheap gas. Otherwise it could be easily making a $100 profit per 1,000 cubic meters, or even more on European markets.

Beneficiaries
Now Ukraine’s state budget is set to save $3 billion yearly, said Ricardo Giucci of the German Advisory Group. Benefiting from the deal are large energy-intensive Ukrainian conglomerates, such as Rinat Akhmetov’s Systems Capital Management or Dmytro Firtash’s Group DF, whose incomes depend on the price of gas.
DTEK, SCM’s energy holding, with a yearly need of six billion cubic meters of gas, says it is still moving ahead with energy diversification projects, thus not believing the discounted gas price will last too long.
“It is not known how long this new lowered price will last,” admits Ernst & Young senior analyst Victor Kovalenko. While the Institute of Energy Strategies’ Yuriy Korolchuk adds: “Anyway, after three-five years, the price of Russian gas will reach market levels. But if Ukraine implements additional energy diversification and efficiency projects, then even $500 will not be such a terrible price.”

Diversification projects
While bargaining since 2010 with Russia over a cheaper gas price, Ukraine has been trying to diversify its own energy sources. At first glance, the new price offers a disincentive to halt or at least postpone these efforts. But since alternative energy projects take a long time to bear fruit, they unlikely will be suspended, Ernst & Young’s Kovalenko explains.
Ukraine had previously tried to reduce its dependence on Russian gas by importing gas from Germany. The origin was actually Russian gas but it was $2-$10 cheaper per 1,000 cubic meters. According to the framework agreement, Naftogaz was supposed to purchase up to 10 billion cubic meters of gas before 2017.
Ukraine has stopped importing gas from Europe after the Dec. 17 deal though. “Overall, the market sees no gas deliveries to Ukraine from the West at all since Jan. 1,” Germany’s RWE executive affairs manager Helmut Weintögl told the Kyiv Post.
Ukraine appears to have also scrapped a nationwide gas well exploration program worth $3 billion. But the extraction of shale gas remains an economically efficient project, admits Ukraine’s Prime Minister Mykola Azarov. Global energy giants Royal Dutch Shell and Chevron are country’s partners in shale gas production sharing agreements which is expected to produce notable results in 3-6 years.
In addition, Italy’s Eni SPA and France’s EDF signed in 2013 a production sharing deal to develop hydrocarbon blocks off the Black Sea shelf. Another offshore PSA project was signed with a consortium led by ExxonMobil the same year.
In addition, Ukraine and China are aiming to in September launch a synthesis gas production project. The plant could provide the country with 4 billion of cubic meters of gas yearly costing $250-260 per 1,000 cubic meters.
A liquefied natural gas project has been suspended after a fiasco in November 2012 involving an alleged imposter who officials believed was representing a Spanish energy company.