Losing his clout.

Photographer: Dmitry Astakhov/AFP/Getty Images

How Ukraine Weaned Itself Off Russian Gas

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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Not so long ago, Russia could bend Ukraine to its will by threatening to cut off natural gas supplies. Now, Russia is offering discounts, but Ukraine is not interested because it's getting plenty of gas in Europe. This change reflects developments in the European gas market that don't augur well for one of Russia's biggest sources of export revenue.

QuickTake Russian Gas

The decline in Ukraine's imports of Russian gas is partly the result of economic stagnation under former President Viktor Yanukovych, a huge drop in output after the 2014 "Revolution of Dignity" and Russia's annexation of Crimea. Ukraine's gross domestic product has shrunk around 19 percent since 2013, and its industrial sector needs less fuel.

A Shrinking Market
Ukraine's imports of natural gas from Russia
 
Source: Ukrtransgaz

That, however, is not the most important reason for the decline in Ukrainian imports. The government is determined to end its dependence on Russia as the two countries are in a semi-official state of war. More than once, Russian threats to stop supplies or raise prices as winter approached forced Ukrainian governments to accept political concessions that slowed the country's drift toward the European Union. In response, Ukraine sought "reverse supplies" from Slovakia in 2014. 

It was a good year to experiment: The winter of 2014 was warm in Europe, and there was a surfeit of gas. In Slovakia, the gas was Russian, delivered by the state-owned monopoly Gazprom through the Ukrainian pipeline system. Gazprom had tried to ban resale, but those conditions were in violation of European rules. In April 2015, the European Commission cited such stipulations as an example of Gazprom's abuse of its dominance in eastern and central European gas markets. Gazprom, which is trying to avoid steep fines and arrive at a settlement with the commission, could do nothing to prevent its customers from supplying Ukraine. 

In the fall of 2014, Gazprom tried to cut exports to Europe to eliminate "reverse supplies," but, according to a Ukrainian estimate, that cost $5.5 billion in lost revenue and another $400 million in discounts to customers as compensation for failing to meet contractual obligations. In March 2015, Russian exports resumed in full.

Europe has been diversifying its gas supplies for many of the same reasons as Ukraine -- to deprive Russia of its energy weapon and to keep prices down. In the third quarter of 2015 -- according to the most recent European Commission gas market report available -- EU gas imports from Russia increased by 18 percent from a year earlier. Supplies from Norway and Algeria grew 26 percent and 35 percent, respectively. 

Nonetheless, Russia remains Europe's top gas supplier, with a 41 percent share of the market:

European Commission

Russia's monopoly status in eastern Europe is disappearing, however, as its former captive customers open liquefied natural gas terminals. Lithuania, for example, has built one and made a deal to import gas from the U.S., where prices are about half those in Europe. That should soon lower the gas price there from $263 per thousand cubic meters, the highest level in Europe. Thanks to LNG, growing supplies from Norway and North Africa, and the antitrust proceedings against Gazprom, the EU is much better protected from price gouging than it was even two years ago. The Russian company cannot attempt to manipulate with supplies to Europe for fear of losing share in a market that provides 52 percent of its revenue. That threat is all the more potent as Europe's gas consumption is falling, in part thanks to advances in sustainable energy. 

Gazprom is trying to negotiate the construction of a new pipeline to Germany, Nord Stream 2, which would bypass Ukraine, but the project faces political resistance in the EU. And its estimated cost of 9.9 billion euros ($10.7 billion) may be too high given current gas prices. If it is built, it will be for political reasons: Russia wants to take away Ukraine's role as a gas transit route. Europe doesn't really need the pipeline, though; given Gazprom's record, it probably wouldn't decrease prices much.

The net effect is that Gazprom has lost much of its leverage on Europe, and Ukraine can afford to be combative. On Sunday, Prime Minister Arseniy Yatsenyuk said his government wouldn't buy Russian gas at the offered price of $212 per thousand cubic meters because supplies from Europe were available at $200. In 2015, Ukraine doubled gas imports from Europe to 10.3 billion cubic meters, and it now gets 50 percent more from the EU than it does from Russia.

Low energy prices have diminished Russia's ability to use its status as an "energy superpower" to exert influence on its western neighbors. The efforts of Europeans to liberalize and diversify their gas market, however, have been at least as effective in curbing President Vladimir Putin and making it easier for Ukraine to break out of Russia's grip. It's too early, however, for Ukrainians to cry victory. If Ukraine's economy rebounds strongly, they will probably have to negotiate with Moscow from a position of weakness again. Local production and European imports will not be enough to meet the needs of a rebuilt industrial sector, at least in the next two or three years. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor responsible for this story:
Max Berley at mberley@bloomberg.net