Can Ukraine Salvage Huge Gas Transit Loss in Time?

Ukraine has four years at most to get its house in order and get the economy on some kind of solvent basis, before the gas through Ukraine is shut off and $3 Billion in transit fees disappear from GDP

Tue, Jun 2, 2015
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2014 Russia sent 146.6 BCm of gas to Europe - existing pipelines that do not transit Ukraine have a capacity of 104 BCm - Turkish Stream will add another 62 BCm

Anyone who has not sleepwalked through the gas-price squabble between Russia and Ukraine since the Great Freedom Jubilee known as EuroMaidan is aware that Russia has grown fed up with Ukraine’s posturing and loose grip on reality – neither being a quality that is endearing or inspirational of confidence in its reliability as a gas-transit country for Europe.

Russia has had projects underway for some time to gradually reduce its reliance on Ukraine as a gas-transit corridor for Russian gas since the stand-off in 2009, in which Ukraine was siphoning off gas intended for Europe for its own use free of charge, while Russia was expected to just make up the difference – Ukraine was confident Russia was without alternatives, since it would not dare shut off Europe’s gas.

Which it did, of course, initiating a panic and a lasting reputation for Russia as an unreliable energy partner. Nothing much was ever said about Ukraine stealing gas; Europe made a few comments to the effect that there was wrong on both sides, and left it at that, and ever afterward the narrative was that they knew Russia accused Ukraine of stealing gas, but where was the evidence?

Russia constructed the Nord Stream pipeline, and partially completed South Stream, the two of which together would handle the entirety of gas shipped to Europe, without going through Ukraine.

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The EU dug in its heels, and went on about how everyone needs rules and Russia would have to abide by the Third Energy Package which said the same company cannot own both the gas and the pipeline, and lots of other twaddle although it simply hands out exemptions to its own suppliers, and Russia canceled South Stream. The EU was jubilant – it had put those Russkies in their place, by God!

Which brings us, skipping over many other details which are of great import but not germane to the gas situation, to where we are now. Russia has announced it will construct Turkish Stream instead, delivering the same amount forecast for South Stream – 63 BCm – to the Turkish/Greek border. If Europe wants gas, it can build pipeline infrastructure to take it from that point. If not, fine – start busting up Granny’s piano for firewood. And none – as of 2019 at the latest but probably around 2017 – will go through Ukraine.

Just before we get started on what the future might look like for Ukraine if (when, actually) it loses its status as a gas-transit hub for Europe, not to mention if the current civil war drags on – there was a practical reason of some immediacy for the construction of South Stream, and it makes Europe’s behavior look even stupider and more short-sighted in the short to medium term.

Ukraine’s Gas Transit System (GTS) was constructed between the 1960’s and 1980’s, and has had no serious overhauls or maintenance in more than 25 years.  Gazprom estimated the cost of upgrading and conducting maintenance on the GTS at $19.5 Billion. Where would that come from? Has Ukraine got $19.5 Billion lying around, collecting dust? Ha, ha. Has Europe? Hardly. Where would these funds come from? I suspect you know.

Ukraine earns around $3 Billion a year from gas transit fees. How is the loss of this income going to impact Ukraine, in view of its medium-term economic forecast?

The currency has fallen off a cliff, averaging 7.29 to the U.S. dollar between 2002 and 2015, spiking to a record low value of 33.5 to the dollar in February of 2015 and currently at a ruinous 20.44
The currency has fallen off a cliff, averaging 7.29 to the U.S. dollar between 2002 and 2015, spiking to a record low value of 33.5 to the dollar in February of 2015 and currently at a ruinous 20.44

As a starting point, it would be hard to envision a more dramatically effective program of economic ruin than what has been done to Ukraine by its western friends.  The currency has fallen off a cliff, averaging 7.29 to the U.S. dollar between 2002 and 2015, spiking to a record low value of 33.5 to the dollar in February of 2015 and currently at a ruinous 20.44.

Whoever wrote the summary apparently wanted to camouflage the moment of disaster by averaging the value of the hryvnia from 2002 to 2015, because the value declined steadily throughout 2014 and can be traced almost to the minute to the Euromaidan demonstrations, accelerating to a screaming power dive after they turned violent and cratering with the collapse of the Debaltseve cauldron. 

The stock market has fallen to a quarter of its value in 2008. The most recent GDP Growth Rate is a contraction of 3.8% in the final quarter of 2014 – certainly worsening since then – and annually is a jaw-dropping contraction of 17.6%. Helpfully – I meant that sarcastically – the official unemployment rate has soared to 9.7% over 2013’s low of 7.6%, and has been over 9% since the beginning of 2014, while inflation has bulleted its way up to 60.9%. All these are figures the state statistics service will admit to. Meanwhile, its hapless government merrily enacts a debt moratorium, authorizing itself to put a hold on payments to its creditors, even as it doubles “defense spending”.

Anyway, on to the sometimes comical dynamics of the European gas business. I think my favourite is the smirking strut executed by various countries as they claim to be “weaning themselves off of Russian gas” by importing gas from some other European country that is a net importer of Russian gas. Like Poland, for example. Kiev was quite proud of itself when, in 2012, it reduced its imports of Russian gas by taking delivery of gas from RWE in Poland on a trial basis. 

These imports continued into 2013 – a year in which Poland (which is also “weaning itself off of Russian gas”) took 60% of its gas from Russia. They’ve wised up now, though, and plan to import significantly more gas from Germany…which gets 38% of its gas from Russia. 

Oh, and they’re building an LNG terminal into which they plan to import LNG from Qatar via tankers. More expensive than pipeline gas, of course, which is just good economics by European standards, but at least they can fly a Polish flag on the LNG terminal. You just can’t put a price on national pride, can you? And they’ll be able – in their dreams – to say goodbye to gas imports someday from that evil undemocratic Stalin dictatorship of Russia in favour of freedom gas from the smiling Qataris, ruled through a constitutional monarchy in which the Emir exercises absolute power and whose heirs come from the male branch of the al-Thani family.

Meanwhile, Ukraine itself remains the fifth-heaviest consumer of natural gas in Europe, at some 55 BCm annually. Mind you, it should realize significant savings in consumption by the almost-complete loss of its heavy industry sector, most of which is in the east – every cloud has a silver lining, what? But Ukraine’s domestic production peaked at 68 BCm forty years back, has been in decline since then and now amounts to about 20 BCm – less than half its current consumption.

So in order for Ukraine to wean itself off of Russian gas, it is going to have to either cut its consumption in half or buy reverse-flowed gas from other European countries – using mostly handout money, since it is going to lose $3 Billion off the top of its GDP which is currently contracting at a rate of more than 17% per year. Put that way, it doesn’t sound too hopeful, does it? Mind you, the EU is doing its bit to help by insisting on reforms which have doubled the price of gas for household use, even as the currency has shrunk to about a third of its previous value.

In 2014, Gazprom sent 146.6 BCm of gas to Europe, 62 BCm of it through Ukraine. Through existing pipelines Nord Stream, Blue Stream and Yamal Europe, Gazprom is capable of delivering 104 BCm of gas to Europe without a whiff of it going through Ukraine. South Stream would have upped that by 62 BCm. Its replacement, Turkish Stream, will deliver the same amount to the Turkish border with Greece, some 47 BCm of which could be available to Europe.

The way I see it, Ukraine has – at the outside – four years to get its house in order and get the economy on some kind of solvent basis, before the gas through Ukraine is shut off and $3 Billion in transit fees disappear from the GDP. At the same time the country will be left with a transit system that, even if it is used only to move gas around the country for domestic use, has not been upgraded or maintained in 25 years and needs almost $20 Billion spent on it. That’s not even figuring in the Billions upon Billions in war damages, the loss of nearly a third of its tax base through secession and the almost complete depletion of its currency and gold reserves.

Europe made it clear recently that admission to the European Union is not in the cards for Ukraine, which is reassuring, in a way, because it means at least a few people in Europe are still capable of thinking beyond the weekend. Ukraine’s economy is being preserved on life support to save the dirty, messy embarrassment of a public default, because the west is entirely and totally to blame for Ukraine’s economic disaster.

The west hand-picked the government, and then encouraged it to re-take its eastern regions by military force. Ukraine faces a future in which it will be broke and friendless, drifting aimlessly at the whim of whoever will lend it money.

And when you think about it, the Maidanite zealots and the fascist strutters are a minority, coming mostly from the west of Ukraine and Kiev. That still leaves a lot – millions – of Ukrainians who did nothing to bring this calamity upon themselves, but who will nonetheless suffer the consequences of their leaders’ idiocy and greed and the meddling of western interventionists who will accept ruining Ukraine so Russia can’t have it if they cannot win it.

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