Shifting energy trends blunt Russia’s natural-gas weapon

While Russia flexes its military might at its Black Sea naval base in Crimea, Moscow has another weapon that it has wielded against Ukraine in the past: natural gas supplies.

Russia provides more than half of Ukraine’s natural-gas needs and since 2006 has twice curtailed supplies in disputes over politics, price and late payments. Those supply cuts rattled countries across Europe that depend on the Russian pipelines that run through Ukraine.

But changes in the global trade in natural gas have blunted Moscow’s weapon, forcing the Russian pipeline monopoly Gazprom to cut prices worldwide and giving Ukraine slightly more bargaining power.

The boom in U.S. shale gas has left gas-exporting countries shopping for other customers. Europe, as it adds terminals to handle liquefied natural gas, will be able to offset its own declining production with supplies from countries such as Qatar. And in 2012, Norway’s Statoil sold more gas to other European nations than Russia’s Gazprom.

“Since the Russian supply cuts in 2006 and 2009, the tables have totally turned,” said Anders Aslund, a fellow at the Peterson Institute of International Economics who has advised Russia, Ukraine and Kyrgyzstan. Aslund said Ukraine once rivaled Germany as Gazprom’s biggest customer. Now, he said, “Gazprom’s challenge is to stay in the Ukrainian market.”

In December, Gazprom said it would discount the price paid by Ukraine, cutting it from about $11.50 per thousand cubic feet to $8.10. But that only brought Ukraine’s prices roughly in line with those being paid in other parts of Europe. Gazprom said it would review the price every quarter, meaning a new reset is possible at the end of March.

As clunky Soviet-era factories and mines have become more efficient or gone out of business, Ukraine’s domestic gas consumption has dropped nearly 40 percent over the past five years, cutting its imports from Russia in half, according to a report by Sberbank Investment Research.

Domestic consumption might drop further if Ukraine trims the generous subsidies it gives households using natural gas, although so few households are paying their bills that it might not matter. “People will go from not paying the lower price to not paying the higher price,” said Thane Gustafson, senior director of Russian energy for the consulting firm IHS CERA.

The gas subsidies and delinquent payments lie at the center of Ukraine’s economic problems and tension with Moscow. Even if residential customers paid up, the Ukrainian state energy company, Naftogaz, would lose money on those sales. That contributes to its failure to keep up payments to Gazprom, which on Feb. 3 said Naftogaz owed $3.3 billion for deliveries over the previous 13 months. Naftogaz’s losses will grow as it sells in the battered local currency and buys gas priced in dollars, Sberbank noted.

“An inefficient and opaque energy sector continues to weigh heavily on public finances and the economy,” the International Monetary Fund said, noting that energy subsidies reached 7.5 percent of Ukraine’s GDP in 2012. “The very low tariffs for residential gas and district heating cover only a fraction of economic costs and encourage one of the highest energy consumption levels in Europe,” the IMF said in December.

In the long run, Ukraine could boost domestic production. Late last year, it signed shale gas accords with Chevron and Royal Dutch Shell; each will invest $350 million in five-year exploration programs and $10 billion for development in the western part of the country, Ukrainian officials have said. However, Chevron, whose block covers 1.6 million acres, said drilling hasn’t started. It still needs to iron out an operating agreement with its partner, the mostly state-owned firm Nadra Oles’ka, said Chevron spokesman Kent Robertson.

The ousted government had also been negotiating with a group led by Exxon Mobil, which wants to explore for oil and gas in a deep-water block in the Black Sea. In January, as protesters thronged the square in the heart of Kiev, Kevin Biddle, Exxon Mobil’s vice president for Europe, traveled to the city to negotiate.

Now, the upheaval of the past two weeks has thrown Ukraine’s gas strategy into greater confusion. “There is no government and there are no agencies to do business with,” said Simon Pirani, senior research fellow at the Oxford Institute for Energy Studies. “How high up the list of priorities it is is anyone’s guess.”

“We remain hopeful that negotiations . . . can resume at the appropriate time,” Exxon Mobil spokesman Patrick McGinn said.

Even if the deals with foreign companies advance, Ukraine will need to import about half of its gas needs, meaning that relations with Gazprom remain important.

In past years, Russia tied its natural gas prices to crude oil prices, but as gas supplies grew more plentiful and crude oil prices soared, customers resisted. In 2012, many European industrial users and power plants switched to coal, and Russia agreed to renegotiate. The link between gas and oil prices has been severed for about half of Russia’s gas sales. Gazprom also agreed to eliminate contract clauses that said a country such as Germany could reship Russian gas only with Gazprom’s approval.

As a result, Ukraine ended up paying more than Gazprom’s customers in Germany, and last year Ukraine imported small quantities of natural gas from Germany and Hungary through pipelines in Slovakia and Poland, experts say. Germany buys gas from a variety of countries, but rerouted Russian gas has effectively been undercutting other Russian gas.

“Ukraine has reduced its consumption of Russian gas, which puts them in a less vulnerable situation. Also the hardest part of winter is over. And there is a fair amount [of gas] in storage,” said a senior Obama administration official who spoke on the condition of anonymity because of the sensitivity of the issue. “Ukraine is obviously still in a precarious situation,” he added, “though very different from what it was in 2009.”

Steven Mufson covers energy and other financial news.
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