March 2, 2018, by Leonid Bershidsky
Russia and Ukraine may be practically at war with each other, but they are joined at the hip by Ukraine’s gas transit system, business partners in one of the world’s biggest energy export channels. On Wednesday, the company that owns the Ukrainian system, Naftogaz Ukrainy, won a $2.56 billion verdict that ends a four-year arbitration fight in Stockholm. The ruling, almost equal to the fine imposed last year by the European Commission on Google, shows that talk of Russia’s ability to weaponize energy exports is far-fetched today.
In a now-infamous 2009 deal, Ukraine signed up to buy a certain amount of gas from Russia — pledging to make up any shortfall with cash. In return, Russia agreed to pump a certain amount of gas to Europe via Ukraine, guaranteeing transit fees. Somehow, those certain amounts were only guaranteed for a short time — until 2010. The deal was so unpopular in Ukraine that former Prime Minister Yulia Tymoshenko was imprisoned for signing it. She was only freed after Ukrainians deposed President Viktor Yanukovych in 2014. The parties to the contract, however, continued fighting: Ukraine stopped buying as much Russian gas as it promised, soon turning to Slovakia for its import needs to avoid dealing directly with Gazprom, and the Russian company kept transit to Europe lower than agreed. Gazprom claimed Naftogaz owed it $56 billion; Naftogaz wanted $16 billion. Now, the huge numbers have finally stopped flying around Stockholm courtrooms.
The upshot is that Naftogaz owes Gazprom $2 billion for failing to honor the “take or pay” clause; it also must resume buying gas from Russia this year at a rate of 5 billion cubic meters annually and pay for 80 percent of that even if it doesn’t. For its part, Gazprom owes Naftogaz $4.6 billion in unpaid transit fees. On a net basis, this is a huge victory for Ukraine, an extra year of transit revenues and some 7 percent of Gazprom’s European export revenues for 2017.
Gazprom objects to the ruling, saying arbitrators took opposing positions on the heart of the problem: Economic distress tightened the market for gas on both sides of the deal. But that isn’t contradictory when considering the circumstances: Ukraine owes its difficulties to Russian aggression in Crimea and a Russian-instigated war in its eastern regions; Europeans merely faced a cyclical downturn. In any case, it would be difficult for Gazprom to wiggle out of paying, since the 2009 contract stipulates that the Stockholm tribunal’s decisions are final and cannot be appealed. Even if Gazprom fails to pay cash, Ukraine can offset the cost of the gas it imports against Gazprom’s debt. Gazprom’s shares were down some 6 percent on Thursday.
Much has been said — particularly by U.S. politicians and commentators — about Russia’s ability to use energy exports as a tool of political pressure. The Stockholm ruling, however, is only the latest evidence that this is a false scare. Even though the 2009 deal was signed after Russia cut off supplies to Ukraine and Tymoshenko had to act in a hurry to prevent gas shortages during the cold season, Gazprom has been squeezed by the international arbitration clauses in the contract. Ukraine, in effect, has been able to do whatever it wanted, including refrain from purchasing any fuel from Gazprom and going to its other customers in eastern Europe. Gazprom would have liked to punish the Slovaks but couldn’t do that either, since the European Commission’s antitrust regulators had threatened to throw the book at it for abusing its monopoly position in some markets. Gazprom has had to play nice, remove “take or pay” clauses from its European contracts and lower prices. Now, it actually owes $2.56 billion to Naftogaz. If this is what weaponization looks like, then Gazprom has been best armed to shoot itself in the foot.
The Ukrainian contract runs until 2019. Gazprom managers — and Kremlin politicians — realize, however, that they can’t make any kind of friendly deal with Ukraine. There will be new conflicts and new arbitration cases until relations between the two countries normalize, an impossibility while Russia maintains its grip on Crimea and pressure in east Ukraine. Since the Kremlin doesn’t intend to compromise in either area, that pretty much means forever. That explains the urgency of the NordStream 2 project — a $11.5 billion pipeline from Russia to Germany across the bottom of the Baltic Sea that would enable Russia to bypass Ukraine.
At a joint press conference with Austrian Chancellor Sebastian Kurz on Wednesday, Russian President Vladimir Putin said NordStream 2 wasn’t meant to be an alternative to the Ukrainian pipeline system: “If Ukraine presents economically grounded parameters for the use of its gas transport system, we have nothing against continuing cooperation with Ukraine. That’s just the question of the volumes to be pumped through.” In a January blog post, Georg Zachmann, an economist with the Bruegel think tank in Brussels, also called on Ukraine to “offer a trustworthy, economically sound alternative to Nord Stream 2” by unbundling the gas transport system from oil and gas production, picking a trustworthy operator to run it and offering a predictable tariff policy. But there’s no avoiding the elephant in the room: The way things stand, there’s no way Russia and Ukraine can cooperate normally on a major project. It would be too schizophrenic an arrangement.
NordStream 2 is Russia’s desperate attempt to escape that trap. Politically, perhaps, it shouldn’t be allowed to do that: Any lever to force Russia into making amends to Ukraine can be useful. Economically, however, it might benefit European gas buyers not to be hostages to the dysfunctional Russian-Ukrainian relationship. That explains why Germany is pushing ahead with the project despite opposition on the part of eastern European countries, especially Poland.
As for the weaponization of energy deals, one needs to look no further than Exxon Mobil’s decision to abandon its joint ventures with Russia’s state-owned oil company Rosneft after U.S. sanctions paralyzed a major offshore drilling venture in the Arctic. Unlike Russia, beaten into submission by European regulators and courts, the U.S. has plenty of power to extend its punitive policies into the energy realm.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners. 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.