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Implications of the recent Russia-Ukraine gas transit deal for Ukraine

Simon Pirani is a Senior Research Fellow on the OIES Natural Gas Programme, has published widely on the development of natural gas markets, and changing consumption patterns, in the former Soviet Union. He was editor of, and contributor to, the programme’s multi-author volumes The Russian Gas Matrix: How Markets are Driving Change (OUP, 2014) and Russian and CIS Gas Markets and their Impact on Europe (OUP, 2009). He has written and co-written a series of papers and articles on the Ukrainian gas sector and Russo-Ukrainian gas relationships, and on Central Asian and Caspian gas markets.

Simon’s most recent book is Burning Up: A Global History of Fossil Fuel Consumption, published by Pluto in 2018. For information please click here.

Prior to joining the Institute in 2007, Simon wrote about Russia and Ukraine as a journalist and historian. He is the author of The Russian Revolution in Retreat (Routledge, 2008) and Change in Putin’s Russia: Power, Money and People (Pluto, 2009).

What are the critical implications of the Russia-Ukraine gas transit deal for Ukraine?

Since the 1990s and through the 2000s, previous gas agreements between Russia and Ukraine linked the terms for gas imports into Ukraine and those covering the transportation of gas across Ukraine to Europe. The last transit gas contracts concluded in 2009 were subject to an enormous amount of dispute. Later on, the change of government in Ukraine in 2014 and military conflict in eastern Ukraine that followed further deteriorated uneasy energy relations between Ukraine and Russia.

However, a new agreement reached in December 2019 put to an end a long period when Naftogaz negotiated with Gazprom against the background of a broader political agreement between Russia and Ukraine. The new agreement in place covers transit of gas across Ukraine to Europe without linking it to the sale of gas by Gazprom for Ukraine’s internal consumption.

Also, it is an agreement between Naftogaz Ukraine and Gazprom, but the services to transport the gas across Ukraine are being bought by Naftogaz from a new company called Gas Transport System Operator of Ukraine (GTSOU). This new company operates on the basis quite similar to the way that transmission system operators work in other CEE countries and EU. GTSOU operates Ukraine’s gas transportation system, which, after a long period of discussion and delay, has been unbundled from Naftogaz. At the same time, GTSOU also manages the gas flow from companies that are gas producers in Ukraine as well as gas flows entering Ukraine on its western border with the EU countries.

Moreover, this latest agreement gives us five years to move towards the situation where the transit of Russian gas across Ukraine will be a much smaller part of the Ukrainian economy and the Ukrainian energy sector compared to the past. The new agreement provides for 65 bcm to be transported this year and 40bcm per year in 2021-24. In this regard, I think it is well understood by all companies in the Ukrainian gas sector that the volumes of Russian gas transported across Ukraine to Europe will be gradually reduced. Also, everyone is aware that GTSOU will have to work out how to reduce the size of the extensive gas transportation system, which is no longer needed by Russia, Ukraine, or Europe. The key reason is that Russia and Gazprom are keen to finalize additional pipelines to Europe. Specifically, they want to complete Nord Stream 2 and the second part of the Turkish Stream. The goal of these new pipelines is to provide alternative gas transit routes to bypass Ukraine as part of Russia’s transit diversification strategy.

Many people in Ukraine worry that these pipelines will take away significant revenue from Ukraine. However, I see it quite differently. Certainly, the revenue from gas transportation will go down, but now resources can be concentrated on developing an energy sector appropriate to the 21st century. Ukraine is clearly no longer dependent on purchasing gas directly from Russia, and has not done so since 2016. Also, its energy sector can focus instead on energy efficiency, reduction in gas usage, and increase of renewables to generate electricity. In the past, it was impossible to get on to reforming the Ukrainian energy system due to constant disputes between Russia and Ukraine. Today, there is a new window of opportunity for the Ukrainian government to facilitate the transformation of the energy sector of Ukraine.

Is the future of Ukraine as the main gas transit route to Europe bleak?

I want to stress that Naftogaz Ukraine will get revenues amounting to 7.2B USD paid for transit services in 2020-24. My point is that both the second part of Nord Stream and Turkish Stream will be completed, and Gazprom will prefer to use these alternative gas transit routes to Europe. Also, the gas demand in Europe will not necessarily be any higher than now. We need to see the transit of Russian gas to Europe as a business in decline as Europe is gradually transitioning to a more sustainable energy model.

Additionally, the amount of gas that Ukraine itself requires has fallen sharply. Ukraine consumes about half of the amount of gas it consumed 15 years ago. Apart from that, the coal industry was hit heavily by the ongoing military conflict in eastern Ukraine. I think in many cases, power generation will move towards renewables away from coal shortly.

And finally, Ukraine is far behind the EU countries in terms of renewables and energy efficiency, and it needs to focus on implementing measures to save energy system in Ukraine to make it more effective. Also, it needs to face the fact that new alternative pipelines will be put into operation soon and that there is no prospect for gas transportation business to grow in the near future. New executives of GTSOU also expressed such feelings about the situation in the market. Sergei Makogon, the GTSOU CEO, gave a presentation during the latest energy forum in Ukraine in which he mentioned the reduction of gas transit capacity to 50-60 bcm per year as inevitable and need to transform the current gas transportation system of Ukraine.

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