Despite new projects such as Nord Stream 2 and Turkish Stream, the transit of gas via Ukraine will continue, and the modalities need to be agreed, writes Danila Bochkarev.
Danila Bochkarev is a Senior Fellow at the EastWest Institute. The opinions expressed in this article solely reflect the views of the author, not of his organisation.
Last week business and political leaders of the EU, Russia and Ukraine met in Brussels to discuss the future of natural gas transportation through Ukraine after the expiry of Gazprom-Naftogaz transit contract at the end of December 2019, underlining the importance of the transit issue for the EU, Russia and Ukraine.
The launch of the new pipelines supplying Russian gas to Europe – Blue Stream, Yamal – Europe and Nord Steam-1 (NSP1) diversified the routes to Europe, but initially led to a significant decrease in Gazprom’s transit via Ukraine.
Consequently, the share of transit handled by the Ukrainian system (based on Ukrtransgaz data) decreased from 81% in 2005 – 125 billion cubic meters a year (bcm) to 42% – 67.1 bcm in 2015.
However, higher demand for Russia’s pipeline gas in Europe led to an increase in gas volumes shipped via Ukraine in the following years. In 2016, gas transit increased by 23% to 82.2 bcm and in 2017 gas flows via Ukraine further increased to more than 93 bcm or roughly a half of Gazprom’s exports to Europe and Turkey. Last year, transit volumes went down by 7% to 86.78 bcm, while the NSP1 run above its nominal capacity of 55 bcm.
Depending on the chosen Gazprom strategy for marketing gas in Europe, the launch of the Nord Stream-2 and the Turkish Stream pipeline would impact natural gas flows via Ukraine. However, various studies agree that the new transport system won’t fully stop the transit of Russian gas via Ukraine.
Pipeline transportation capacity is not just about annual capacity – daily flows matter as well. For example, demand during the winter peaks might be significantly higher than in spring or during the summer period.
Pipeline maintenance also increases the call on alternative routes and Ukraine’s gas transportation system (GTS) is the only route providing flexible spare capacity in times of peak demand, as other pipelines transporting Russian gas to the EU are full. In 2018, NSP1 transported 58.8 bcm, indicating that it operates at capacity.
A decrease of indigenous production and increase in consumption will lead to higher demand for imported gas. The Dutch government took a decision to halt production at the Netherlands’ largest gas field Groningen by 2030.
Groningen’s shutdown might already happen this year based on the pending the Dutch High Court ruling. At present, Groningen’s production ceiling for October 2018 – September 2019 is set at 19.4 bcm – less than a half of the 2014 output (42.5 bcm).
Meanwhile, in 2017 EU-28 gas consumption increased by 6% to 491 bcm or 72 bcm higher than in 2014. According to WoodMackenzie data presented in December 2018, Europe will need to import an additional 77 bcm by 2025. This import gap of 77 bcm is likely to be filled in both by LNG and pipeline gas, mostly from Russia and the Caspian thus increasing the call on the Ukraine’s GTS.
Market observers like IHS Markit highlight the fact that the flow of gas through Ukraine “would play an important role in meeting peak European demand at times of high seasonal requirements… Ukrainian transit volumes are then seen to recover in the mid-2020s as Europe’s indigenous production continues its decline.”
While there is agreement in market circles that Ukraine’s route will be used in the future, the expectations of the key stakeholders as to the actual capacity required and volumes flowing are quite different.
The Ukrainian government, Naftogaz and market observers quote numbers ranging from 40-60 bcm/year to 141 bcm/year, which would represent a 100% utilization of the system’s nameplate capacity. In 2016, Gazprom estimated future transit requirements at 10-15 bcm/year, albeit before much of the current market developments around Groningen had fully unfolded.
Media reports, including RadioFreeEurope/Radio Liberty’s wire, quoting undisclosed sources reported that the European Commission proposed Russia and Ukraine to conclude a 10-year transit contract with a 60 bcm/year ship-or-pay clause and possibility to ship additional flexible volumes – up to 30 bcm/year. The question remains if these volumes are reflective of the market realities. For the next decade, IHS Markit estimates the need in the Ukraine transit in a range of 11-28 bcm. Jack Sharples from the Oxford Institute for Energy Studies (OIES) stresses that “gas transit via Ukraine in volumes greater than the 26 bcm/year …. will depend on the European Commission and European gas importers, and their insistence that gas transit via Ukraine continues.”
Various factors – other than agreeing volumes more reflective of the market realities – complicate the negotiation process. There is an ongoing debate on the outcomes of the Stockholm Arbitration with a new claim against Gazprom regarding revision of the transit tariff (in 2018-19) submitted by Naftogaz to the Stockholm arbitration.
This does not help the negotiation process – Gazprom has mentioned the settlement of disputes as a pre-condition for the constructive relations with Naftogaz.
Speaking to Platts on 19 July 2018, Prof. Jonathan Stern from the OIES “find[s] it difficult to imagine that it will be possible to establish a lasting transit agreement while Ukrainians are attempting to seize Gazprom assets and both sides are pursuing multiple (and increasing numbers of) arbitration cases against each other.”
Ukraine’s presidential election and appointment of the new European Commission create big unknowns regarding personalities to be involved in the negotiations. So negotiators have their work cut out for them for the coming weeks and months.
Nevertheless, the bases for an agreement are clear: both sides have an interest in coming to an agreement. Clearly, the 21 January meeting was taken seriously by all stakeholders concerned:
The fact that vice-president of the EU Commission, Russia’s and Ukraine’s key ministers, Gazprom’s and Naftogaz’ CEOs were at the negotiation table proved that all sides understand the importance of reliable and uninterruptable gas transit via Ukraine.
Negotiations will be complex, but all sides being willing to accept market realities, a solution can be found.