Derailing Russia-Ukraine gas transit talks would harm the EU consumer

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of EURACTIV.COM Ltd.

File photo - A worker poses on request of press photographers next to a turbine at the Siemens Gas Turbine Plant in Berlin, Germany, 2 March 2017. [Clemens Bilan/EPA/EFE]

US Sanctions on Nord Stream 2– especially since their imposition is officially supported by the management of Ukraine’s Naftogaz – could complicate if not completely derail the negotiation process between Moscow and Kyiv on the future of gas transit, writes Danila Bochkarev.

Danila Bochkarev is a Senior Fellow, EastWest Institute (Brussels). The opinions expressed in this article solely reflect the views of the author, not of his organisation.

Gas transit negotiations between Russia and Ukraine advance despite difficulties. After the talks held in Paris on 9 December, President Volodymyr Zelenskiy confirmed that the issue of gas transit had been “unblocked”.

US Sanctions – especially since their imposition is officially supported by Naftogaz management – could, however, complicate if not completely derail the negotiation process.

Calling for the sanctions on their competitors is also hardly compatible with the market-based behaviour of a European energy company.

In an interview with NBC News, Andriy Kobolev, CEO of Naftogaz, said that “if [the sanctions] are signed and implemented, I believe the European gas market will benefit significantly, and Ukraine will benefit. And European consumers will benefit.”

Mr Kobolev referred to the “Protecting Europe’s Energy Security Act” (PEESA) which claims to be aimed at defending the European Union’s (EU) energy security by placing sanctions on European companies constructing the Nord Stream 2 gas pipeline.

It is, however, unclear why Europe’s energy security must be defended from the other side of the Atlantic and how European consumers will benefit from the imposition of a sanction that seeks to stop an additional pipeline coming on stream.

Apart from the question how sanctioning new pipelines would serve to protect the EU consumer, the problem with Mr Kobolev’s assertion starts with the diagnosis: no one in the EU will doubt that European energy security has made significant process over the last years.

Every official metric by the European regulator (ACER reports) or an infrastructure association (ENTSOG Security of Supply Simulation) shows that market integration, supply security and resilience are substantially, improving even as Russian gas imports have inched up.

Expansion of the EU’s LNG and pipeline infrastructure (including interconnectors between member states) plays an important role in mitigating energy security risks.

In the last decade, Europe’s LNG receiving capacity more than doubled and reached 212 bcm/year, interconnector capacity to ship gas from West to East already now exceeds the gas demand in Eastern Europe.

Europe’s idle regasification capacity reaches over 160 bcm/year – largely enough to replace all Russian exports to the EU-28 (155.7 bcm in 2018). The availability of a vast choice of affordable supplies significantly improved the sense of confidence among European consumers.

Sanctions against the Nord Stream 2 will lead to a reduction of supplies to Europe, which would have to be supplemented by procuring additional LNG. The result is an increase in natural gas prices.

The Institute of Energy Economics (EWI) estimates that every day that Nord Stream 2 is delayed would translate into an additional cost of over €20 million per day for European consumers  There are no winners in Europe from this move.

Naftogaz has ambitious gas transit plans but Ukraine’s gas transportation system is vastly outdated: more than 60% of pipelines are more than 33 years old, and only three out of the country’s 542 gas pumping units are less than 10 years old.

Secondly, infrastructure investment will be limited. In 2019-28 Ukrtransgaz, Naftogaz transportation brunch, plans to invest 56.87 billion UAH (US$2.42 billion), including around $1.24 billion for the pipelines and compressor stations.

Currently, only the Urengoy–Pomary–Uzhgorod pipeline (around 30 bcm/year) has money lined up for refurbishment (from the EBRD and other international financial institutions) and beyond that, Ukrtransgaz has only very modest ambitions regarding new infrastructure: most of the funds are committed to the construction of an interconnector with Poland.

It is therefore unclear how this state of affairs is compatible with the plans to secure stable long-term 60-90 bcm/year transit flows and maintain the company’s profitability.

If sanctions, as desired by Naftogaz, delay the Turk Stream and Nord Stream 2 projects further, this is what the European consumer is ultimately stuck with: 40-year-old pipelines with half-hearted modernization commitments only partially funded with international aid money.

The regulatory environment in Ukraine is still far from being fully in line with EU standards. Market observers recognise progress on Naftogaz unbundling but a lot more needs to be done. The reform process was unnecessarily delayed by internal political struggles in Ukraine and electoral campaigns.

In Europe, the lack of progress in unbundling of Naftogaz has been a continuous concern. At the FLAME gas conference in May 2019, Energy Community Secretariat Director Janez Kopac said that Naftogaz was being slow to finalize the unbundling process and that the government in Ukraine “talks a lot about unbundling but is doing nothing”.

On 17 December 2019, the Energy Community Secretariat confirmed – based on the documents submitted by Ukraine’s energy regulator that the gas transmission system operator of Ukraine is unbundled in line with the requirements from European law.

The conformity with the EU rules also means the respect of these regulations. Would new Ukraine’s TSO be willing/able to auction its ’transport capacity’ like a normal European company?

More specifically, would they offer day-ahead booking like any Belgian, Spanish or Danish TSO or would they just push for a long-term agreement at any cost, in an attempt to preserve the transit rent as much as possible?

What would happen in case of the transit interruption? In general, the EU is well prepared for a breakdown of the trilateral gas talks, at least in the short term. However, replacing the gas flows in Europe from storages and extra LNG comes at a price.

Simon Schulte from the EWI estimates that “a three-month period of transit disruption will have strong implications on EU gas prices and hence welfare.”  European consumer would lose 4.1 billion euro as a result of a three-month supply curtailment.

That alone should be enough to motivate Brussels to step up its efforts to bring the transit negotiations to a successful end and to defend European companies against US sanctions.

Last but not least: an interruption of supplies might occur only in case Naftogaz refuses to accept the inflows of Gazprom’s gas.

Mr Kobolev said that if gas continues to flow (without the contract), it will be accumulated in underground gas storage facilities as “gas of an unidentified owner for further proceedings”.

This means that without their desired outcome of a long-term agreement, Naftogaz will simply reject gas transport via the Ukrainian pipelines, even on a short-term basis as foreseen by the European energy acquis.

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