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The leadership of the European Commission, after convincing Ukraine to stop the transit of Russian gas, has achieved its goal of limiting the flow of Russian hydrocarbons to the EU. Brussels seems to be convinced that it can manage without Russian gas, which still fort a couple of months, that is, until the end of December 2024 will transit to Europe through the territory of Ukraine. But after “closing the tap,” Ukraine risks an energy collapse.
The transit of Russian gas through Ukraine has come to an end. But there are some interesting developments ahead.
As the new year approaches, more and more attention is drawn to the anticipated event: Ukraine will not prolong the contract with Russia on pumping Russian gas through its territory. As a result, European consumers will receive 14 billion cubic meters of gas from the beginning of 2025. All the direct participants of the gas market will lose from the termination of the Ukrainian corridor. Ukraine will lose about $1 billion in annual transit payments in 2025, while Russia will lose about $6 billion in export revenues. Slovak operator Eustream and trader SPP will lose up to $1.5 billion in annualized transit fees and commercial margins from gas resale. Gas prices will rise for all of Europe, and some countries will have to face gas shortages. In this zero-sum game, only the European Commission will win, which will get even closer to its long-term goal of denying Europe any energy from Russia by 2027. In this whole story, the most surprising is the position of Ukraine, which, as I will show below, will lose much more than transit payments.
The European Commission is confident that Europe can manage without the Russian gas it receives through Ukraine.
As I noted in my September 6 article on Pluralia, the decision to stop transit was not a sovereign decision of Ukraine, but was imposed on it by the European Commission. Whether it was an emotional impromptu decision or a whim on the Ukrainian side, as it may have seemed from the outside, the EU was very quick to quash any threats to the energy security of its members. But in this case, the EU is not going to stop Ukraine – these are exactly the actions it expects from Ukraine. The non-renewal of the transit contract is the result of systematic work of European politicians with the Ukrainian authorities. This can be documented by the remarks of European Commission energy member Kadri Simson on September 11, 2024. Summarizing the activities of the old European Commissioners on the European gas market, she stated the following: “We remain fully committed to completing the phase out of Russian gas, which can be done without challenging Europe’s energy security of supply. As a first step, together with the Member States we have been preparing for the end of the gas transit agreement via Ukraine. We have done that already for several months. We started preparing two years ago. The EU is ready to live without this Russian gas coming from the Ukrainian transit route.”
Is there a chance that at the last moment it will be possible to preserve transit through Ukraine?
Having categorically refused to transport Russian gas to Europe, Ukraine offered an alternative scheme for using its gas transportation system. The main condition Ukraine has agreed to is the replacement of Russian gas with Azeri gas. A European buyer, such as Slovakia, purchases it at the point of entry from Azerbaijan to Russia or from Russia to Ukraine. The gas buyer then makes its own arrangements for gas transportation through Russian territory and pumps it into Ukrainian underground storage facilities. After that, it can use the gas at its own discretion, including selling it to Europe. Thus, Ukraine in this scheme acts not only as an operator of its gas transportation system, but also as a gas re-exporter. In addition to the above, it requires the participants in this scheme to ensure that the seller of gas, Azerbaijan, and its European buyers receive guarantees from Russia regarding the security of the Ukrainian gas transportation system facilities, i.e. actually provide it with protection in the conditions of hostilities.
The scheme proposed by Ukraine to use its transit gas pipelines is not viable. The essence of Ukraine’s proposals is as follows: if someone wants to use its pipelines, they should take on all the work of organizing transit, as well as all the risks associated with this transit. Ukraine itself is being eliminated from the treaty process.
But it doesn’t look like anyone is willing to take on the burden of organizing such transit. And the implementation of Ukraine’s proposal requires joint work and complex agreements between all interested countries, and non-participation of even one of them makes the implementation of the Ukrainian scheme impossible. According to media reports, Azerbaijan has not been involved in negotiations on participation in this transit scheme for several months. In early October 2024, Russia, represented by Deputy Prime Minister A. Novak, stated that it had not received any proposals on this issue from European countries and the EU. Obviously, the scheme proposed by Ukraine is less attractive for Russia than maintaining long-term contracts with its partners. It is not known whether Russia would agree to the “Ukrainian scheme” even if it were proposed. Actually, its non-participation in the scheme was reported by Austria. The management of Austria’s OMV insists that the gas delivery point should remain at the Austrian border, as stipulated in the contract with Gazprom.
Besides, the clear contradictions in the Ukrainian scheme cannot be overlooked. As much as Ukraine does not want to have any contacts with Russia, it will have to negotiate with Russia to conclude an agreement on joining the gas transportation systems of the two countries. The interconnection agreement is not a mere formality; in addition to legal issues, it stipulates many technical details of interaction between GTS operators. To coordinate these details, it is necessary to create a special Russian-Ukrainian workgroup to outline various regulations.
Let us also recall the stated reason for refusing to extend the transit contract – the intention to deprive the “occupying country” of revenues from gas exports to Europe. But Azerbaijan does not have extra gas, as it already supplies gas to Europe at the limit of its capacity. It will inevitably have to buy it from Russia or enter into an agency agreement with it, which means that the export revenues of the “occupier” will not disappear. This is the main contradiction in the scheme proposed by Ukraine. It creates a precedent for the appearance of pseudo-Azerbaijani gas in Europe, which in fact will remain Russian.
By proposing an obviously impractical scheme for preserving the transit corridor, Ukraine apparently imitates its intention to compromise with its European partners. This is done in order to deflect accusations of provoking a rise in European natural gas prices and even endangering their energy security. Such accusations can have legal ramifications as well. Slovakia, for example, recently reminded Ukraine that it has signed an association agreement with the EU and is therefore obliged to maintain transit. Ukraine responds to accusations of creating crisis situations by saying that it offered its own option to continue transit but did not receive support. Ukraine can also fully rely on the support of the European Commission.
Ukraine is threatened with the shutdown of the gas transportation system.
So, why will Ukraine suffer the most if the transit corridor linking Russia to Europe stops functioning? It is not only and not so much about the loss of about $1 billion in transit payments, which Ukraine will not receive. On a closer look, the net benefit of transit is low. In its corporate report for the first half of 2024, Ukraine’s Naftogaz reported revenue of UAH 20.4 billion ($496 million) from the transit of Russian gas, up 6% year-on-year. However, the cost of transit service amounted to UAH 19.2 billion, or $377 million. Judging by these data, the net income from the transit of Russian gas is quite low, only $119 million ($496 million minus $377 million) for half a year, apparently amounting to $240 million for the year. This amount is not comparable in size to the amount of EU and US aid to Ukraine.
It should be borne in mind that high transit support costs demonstrate the inefficiency of Ukraine’s gas transportation system, which has not been properly financed for many years. The main component of these costs is the payment for fuel gas. As a result, several times more gas is consumed for pumping it than is required by the norm. The wearing-out of the system also leads to high direct gas leaks during transportation.
It would seem that Ukraine has little to lose by refusing to transit Russian gas. If there is no transit, there will be no associated costs. But this is not exactly the case. The value of Russian transit lies not only in profits, but also in the opportunity to optimize natural gas flows within Ukraine.
Firstly, it is Russian gas that provides pressure in the system, which, if it drops below 30 bar, will lead to a complete shutdown of Ukrainian gas pumping units. So, if there is no transit, Ukraine will have to maintain pressure in the system at the expense of its own gas reserves.
Secondly, with the termination of transit, Ukraine loses savings on gas transportation within the country. Ukrainian domestic gas supply is linked to transit. The savings are formed because gas from the transit flow partially remains in the east and center of the country, while the difference on the western border is covered by gas from storage facilities located there. With the disappearance of transit, Ukraine will have to organize the supply of central and eastern Ukraine by reverse flow all the way from the western border.
Although gas consumption in Ukraine has decreased due to population emigration and production closures, the previous heating season showed that gas demand at thermal power plants is still at a high level. And next winter, even more gas may be needed, as there are almost no coal-fired thermal power plants left after the Russian army strikes, so the load on gas-fired CHP plants should increase. Gas in modern Ukraine has taken the next place in the balance after nuclear power plants, displacing coal.
However, there are significant problems with Ukraine’s gas supply for the heating season, which started on October 15. By this date, 13 billion cubic meters of gas has been accumulated in Ukrainian gas storages. This is 200 million cubic meters less than the plan set earlier by the government to Naftogaz.
Ukraine cannot rely on gas from European traders in its underground storage facilities either. EU companies, despite the fact that Ukraine offers some of the lowest storage tariffs, do not risk storing gas here, fearing both attacks on the infrastructure and unauthorized use of their gas. If last year before the heating season European gas traders pumped 3 billion cubic meters into storage facilities, this year they withdrew 60 million cubic meters more than they pumped.
What do we have in the end?
The European Commission leadership, by persuading Ukraine to stop the transit of Russian gas, has achieved its goals of restricting the flow of Russian energy goods into the EU. Europe will do without Russian gas coming through Ukraine, the European Commission has said. But whether Ukraine will avoid a gas collapse in the end, which will not even require Russian bombardment of its gas pipelines, is of little interest to the current EC. All the more so because this problem will be dealt with by the new European Commissioners for Energy, who will receive their powers in November. Although they might find other, more important issues to address.
