Selected issues impacting the future of the Ukrainian Gas Transit System (GTS)

Heikki Lehtimäki,
Managing Partner,
Plan Energy Ltd,
Helsinki, Finland

Ever since the Nord Stream gas pipeline concept was introduced in 2005, for some it was solely a commercial or environmental issue and for the others, the project contained clear geo-economic or geostrategic elements, too. Nord Stream 1 (NS1) is now operational since 2011/2012 and is transporting 55 Billion cubic meters (BCM) of gas a year from Russia (Vyborg) to Lubmin in Germany (system fully operational in 2018).  NS2 pipeline system (also 2 parallel 48-inch lines) is now being laid from Ust-Luga on the Baltic Sea coast in Russia to Lubmin. The construction of the 1 230 km-long pipeline system (also 55 BCM) is about 83% completed.

In the previous issues of the Baltic Rim Economies (BRE), Mykhailo Gonchar (BRE 1/18, 1/16 and 6/11) and Andrii Chubyk (BRE 4/14 and 5/10) have described the impact of NS2 on the future of the Ukrainian Gas Transit System (GTS) as an alternative transportation route for Russian gas to the EU. What follows is an update on the complex situation, due to 1) the recent changes in the EU Gas Directive, 2) the recent development in the NS2 permitting process in Denmark, 3) the impact of the Stockholm Arbitration Court awards in the gas import and transit disputes between Gazprom and NJSC Naftogaz and for Crimea as well as 4) the role of the Trilateral Gas Group (the EU, Russia and Ukraine) in attempting to reach a commonn understanding on the future of gas transit in Ukraine.

  1. At the time of writing this article (15 April), the European Parliament had adopted by votes 465 to 95 (68 abstensions) on 4 April an overhaul on Gas Market rules meaning that gas pipelines from non-EU countries will be covered by the EU Law. This will give legal clarity for the existing and future gas infrastructure from non-EU countries and will clear procedures for when the Commission can grant exceptions. After the formal approval of the EU Council (and publishing in the Official Journal) it will enter into force 20 days later and will cover e.g. NS2 pipeline. Member States have 9 months to bring their national legislation in line of this decision. Jerzy Buzek, rapporteur in the European Parliament, said: ”From now on, all gas pipelines from non-EU countries, including Nord Stream 2, will have to abide by EU rules: third-party access, ownership unbundling, non-discriminatory tariffs and transparency.” (EuroParl Press Release).
  2. Finland, Sweden, Germany and Russia have granted all the environmental permits for the NS2 pipeline to be laid in their Exclusive Economic Zones (EEZ) and Germany and Russia also for the territorial waters. Due to the recent maritime delimitation agreement between Poland and Denmark (and possibly also due to the Baltic Pipe project from Denmark to Poland in the same area), Denmark has requested NS2 to study a third alternative pipeline route in addition to the one going through the Danish territorial waters east of the Island of Bornholm (as NS1) and the other one to the west of Bornholm (EEZ). The new requested route would go to south of Bornholm and would utilize the ”Polish Banana” zone, i.e. the banana shape part of the new delimitation area between Denmark and Poland and often shown in yellow colour on the maps). This request of Denmark may in practice delay permitting by months, if not years, in case appeals would be made against the ultimate Danish decision. A recent Danish law allows the Foreign Minister to veto a pipeline route in the territorial waters on national security grounds.
  3. After the illegal annexation of Crimea and the war in Donbas, imports of Russian gas into Ukraine ceased in 2015 and the transit market of Russian gas to Europe using the Ukrainian GTS changed – due to the commissioning of NS1 in the Baltic Sea. Ukraine used to import directly 59.3 BCM of Russian gas in 2000. Since 2016, gas (also of Russian origin) has been imported only from the West using the reverse flow system. In 2018, imports totalled 10.6 BCM (via Slovakia (Budince GMS), Hungary and Poland). Ukrainian domestic gas consumption has halved (from 2001) to 33 BCM in 2018.  Russian gas transit volumes via Ukraine peaked in 1998 (141 BCM) and the corresponding figure in 2018 was 86.8 BCM. The gas purchase contract and gas transit contract disputes between Naftogaz and Gazprom have been taken to Stockholm Arbitration Court. The Arbitration Award in 2017 – 2018 was 2.6 BUSD (net) in favour of Naftogaz. Appeals are under way. The International Arbitration Court in The Hague awarded Naftogaz separately a 5 BUSD compensation for the onshore and offshore oil and gas reserves and subsoil licenses in Crimea as well as for confiscated oil/gas drilling rigs, supply vessels, infrastructure equipment, etc. German press (Bild 4.4.2019) is referring to a confidential Ministry of Foreign Affairs memo according to which Moscow would put the cancellation of the Stockholm Arbitration court award of 2.6 BUSD as a prerequisite for extension of the gas transit contract between Naftogaz and Gazprom after it will expire at the end of 2019.
  4. The above examples show concretely the huge geostrategic, commercial and monetary significance of the gas disputes between Ukraine and Russia – with direct and indirect impacts on many other countries, too. E.g. Naftogaz earns about 2.5 – 3.0 BUSD in revenue annually for transiting Russian gas to Europe. This accounts roughly for about 3% of the Ukrainian GDP. The Trilateral Gas Group between the EU, Russia and Ukraine is trying to find a solution for the disputes. The EU has suggested a 10-year transit contract with e.g. a minimum of 30 BCM annual throughput. Gazprom has been speaking of only 10 – 15 BCM volumes. Naftogaz unbundling is proceeding and the Ukrainian government is trying to find foreign investors and/or parties to operate the GTS system together with Ukrainian entities. Under today’s circumstances, Nord Stream / Gazprom may need the Ukrainian GTS as a back-up solution after 2019, if/when NS2 will be delayed due the changes in EU legislation and the Danish permitting process. And too small an annual throughput volume for Ukraine is not enough, because operating the GTS requires maybe 15 – 30 BCM – not to get ”rusty”. Also, the GTS would require some additional repair, maintenance and new pipeline section investments. But whether to invest, if the transit contract will not be extended beyond 2019..? Not an easy equation to the parties involved!

To summarize:

“Brussels – Russia’s 55 Bcm/year Nord Stream 2 gas link to Germany will miss its end-2019 start-up target, and may not be fully operational for “some years,” a senior European Commission official said Thursday.

The project is still waiting for a Danish permit, which could take at least another year, and the extra onshore transmission capacity needed to reach customers in southeast Europe would not be available by 2020, the EC’s deputy director-general for energy, Klaus-Dieter Borchardt, told a Politico event in Brussels.” (S&P Global/Platts/11.04.2018).

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