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On the present and the future state of Ukraine as the main gas transit route from Russia to Europe

Marc-Antoine Eyl-Mazzega is a Director of IFRI's Centre for Energy & Climate since September 2017.

Prior to joining IFRI, he spent six years at the International Energy Agency (IEA), notably as Russia & Sub-Saharan Africa Programme Manager, where he conducted oil and gas market analyses and was responsible for institutional relations with these countries and regions. He also held various other positions, such as at the Robert Schuman Foundation, where he was in charge of a Ukraine observatory.

A French and German national, he holds a Ph.D. from Sciences Po Paris in international relations.

1. Ukraine's long term transit contract with Russia expires in December. Will we have a deal or not as to a new one? What do you think?

Ukraine is a full member of the European Energy Community and has been adopting its provisions, including the Third Gas Directive. It means that it can't have intergovernmental relations and agreements as to a gas trade as before. Thus, it has to move from the distance-volume-based system to a capacity-based system with an interconnection agreement in place at the Russian-Ukrainian border, and a fully independent regulator that applies gas transportation tariff in a non-discriminatory way. It would also need a gas transmission operator whose unbundling has been certified by this Ukrainian regulator and the Energy Community Secretary.

When the last gas transit contract was reached between Russia and Ukraine back in 2009, there were none of these elements in place as conditions were different. In an entirely new economic and regulatory environment, it will be challenging to reach a new and satisfactory compromise for all the parties involved. There is a difference in terms of expectations on the part of Ukraine as the main gas transit country from Russia to the EU, and the EU Commission.

Moreover, Russia has not made so far any concrete proposals as to its expectations as well. Thus, currently, it is 1,5 months left to outline conditions and narrow down differences between Russia and Ukraine, and it is not clear if we are close to reaching such an agreement. The likelihood of reaching such an agreement is not very high, and we might have a situation when gas transportation across Ukraine to Europe might be suspended for a few weeks in January.

2. So how do you see this situation evolving right now? The Cabinet of Ministers of Ukraine declared that it wouldn't rule out the possibility of a new intergovernmental agreement for gas transit, and I wonder how they will align it with the obligations mentioned above of the European Energy Community?

There is a lot of work on the plate for the Ukrainian parliament to pass another law to make unbundling a reality and transfer transit assets to a new gas transmission operator. Also, there is a pending question as to the extent to which such a regulator will be able to certify that it abides with the existing EU regulations. Nevertheless, there is a ray of hope as it seems that the Cabinet of Ministers of Ukraine, Naftogaz, and Energy Community Secretariat are aligned as to what and how has to be done. Also, earlier parliamentary elections in Ukraine were an essential factor in increasing the chance of achieving results as delayed elections, and the absence of a new government would make it problematic to reach an agreement in a few weeks.

3. What do you think what does the future hold for Ukraine gas transit route whose role has been steadily declining?

One has to consider several things. There are two new transportation routes from Russia to the European market. The first one is Nord Stream 2, which is not finalized yet due to some remaining regulatory pitfalls, which probably will be addressed briefly, and the pipeline will become fully functioning. In this regard, recently, Denmark granted a permit for part of the Nord Stream 2 pipeline to be constructed near the Baltic island of Bornholm, paving the way to its speedy realization.

Additionally, the TurkStream project, which will go across the Black Sea to bypass Ukraine, is at the more advanced stage and might be finalized even earlier than the Nord Stream 2.

Also, there are other factors that might influence the role of Ukraine as the main transit route from Russia to the EU. As the EU is working on adopting the objective of becoming carbon neutral by 2050, it means that in the long term, fossil fuels will be progressively phased out from the EU energy mix to a more significant extent, which also includes natural gas. As a result, it might also lead to a gradual decline of Russia's gas exports, in turn, ultimately lowering the impact of Ukraine as the main transit route.

Moreover, increasing focus on domestic production among EU member states, coupled with the increasing LNG imports from the US, will also lead to a gradual reduction of gas demand from Russia. At the same time, in today's European political environment and gas market, there is an overall trend of transition from long-term contracts typically signed for 20-30 period to short-term contracts concluded for 5-10 years.

Nevertheless, in the short term, the role of Ukraine will be as critical as before, considering that it is currently transiting about 50% of Russian gas exports to Europe. The European side will focus on bringing Russia and Ukraine to reach a new agreement before the expiry of the gas transit agreement by the end of December. However, it is not entirely clear if such an agreement will be reached, and we could expect the potential suspension of gas exports from Russia across Ukraine.

These are not just negotiations about gas transportation, that is a capacity reservation, duration, flexibility, technical parameters, and tariff, etc. They also include issues related to the Stockholm arbitration or barriers to direct deliveries of Russian gas to Ukrainian customers. The bottom line is the following: Ukraine must accept that volumes will be significantly lower in the future. Also, Russia must accept that Ukrainian transit is still needed in the long run at a substantial level. And that stakes are high as the image of gas could suffer.

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