Gas blackmail again? Russia pressures Europe and threatens to halt transit through Ukraine

Practically the only sphere of joint foreign economic activity between Ukraine and Russia that remains is the transit of energy resources. Russian natural gas and oil flow through Ukrainian pipelines to third countries, predominantly EU members.

After the beginning of active hostilities by Russia in Europe, the use of Russian energy resources significantly decreased. This was due to the introduction of sanctions and the voluntary refusal of some countries from Russian supplies. However, the transit of oil and gas through Ukraine still remains relevant.

European countries are not yet able to completely abandon Russian gas - it is still being purchased by Germany, Italy, Bulgaria, and Austria, as well as oil going to Slovakia, Czechia, and Hungary. This allows Russia to continue to gain considerable profit from the sale of energy resources. Even with reduced sales volumes last year, Gazprom's income from gas exports to Europe exceeded 50 billion dollars due to high prices.

The supply of energy resources through Ukraine brought significant revenues to Russia. Perhaps that's why there have been no attacks on transit facilities from the Russian side. But the situation is changing. Last year, the volume of gas pumping decreased almost twofold - to 20.35 billion cubic meters out of the contracted 40 billion. The trend of reduced transit continues in 2023.

Regarding oil, there was some growth; however, based on the data from the first half of this year, there may be a slight decrease in transit in the current year. Nevertheless, prices for resources are significantly lower than in the previous year, resulting in less high revenue from exports. According to experts' forecasts, gas sales volumes to Europe from Russia will decrease by 75% this year, but the reduction could be more substantial.

Gazprom warns about transit termination

Russian Gazprom informed about the possibility of introducing sanctions against NJSC Naftogaz Ukraine. The head of the company, Alexey Miller, stated on July 7 that this step might be taken due to the arbitration proceedings initiated by the Ukrainian side. He mentioned that Naftogaz has already filed a multi-billion-dollar lawsuit against Russia in the U.S. courts.

"In case such unethical actions by Naftogaz continue, it cannot be ruled out that it may lead to Russia's imposition of sanctions. Then any relations between Russian companies and Naftogaz will simply become impossible," Miller said. Naftogaz has not commented on the possibility of the termination of transit.

As of today, Gazprom and Naftogaz are only connected by the transit contract signed in 2019, which expires at the end of 2024. However, the imposition of sanctions may lead to the prohibition of financial operations between Gazprom and Naftogaz and, consequently, the actual cessation of gas transit.

What arbitrations is Gazprom referring to?

Gazprom refers to two lawsuits filed by the Ukrainian side in arbitration. The first lawsuit concerns compensation for lost property in Crimea. On April 12, the Hague Arbitration Tribunal ordered Russia to pay $5 billion to Naftogaz. The Russian side stated that it would analyze this decision and does not intend to comply with it for now.

Naftogaz, in turn, started the process of enforced seizure of Gazprom's assets in third countries. The United States became the first country where this process began. In June, Naftogaz Ukraine and five other companies from the Naftogaz Group filed a motion with the District Court for the District of Columbia to confirm the decision of the arbitration tribunal.

The second lawsuit concerns the termination of the transit of Russian gas through the gas metering station "Sokhranivka." The lawsuit was filed in September 2022 with the International Arbitration Court in Paris (the venue of arbitration is Zurich). Last year in May, due to the Russian occupation, the Ukrainian side lost control over the compressor station "Novopskov" in the Luhansk region. It received gas from the GIS "Sokhranivka" (located on the territory of the Russian Federation) and was transited in volumes of up to 32.6 million cubic meters per day.

The "Novopskov" CS was captured on February 24, 2022, but the Ukrainian side managed to control its operation until the beginning of May. On May 10, there were reports of Russian interference in the station's operation and its technological processes. Gas from the transit flow began to be supplied to the Luhansk TPP. Firstly, this resulted in financial losses for the Ukrainian side, and secondly, there was a risk of disrupting the operation of the entire GTS due to the lack of pressure control in the system.

The situation was classified as a "force majeure" by the GTS Operator of Ukraine, and on May 11, the transit through "Sokhranivka" was suspended. Gazprom was offered to redirect gas volumes to the GIS "Sudzha." However, the Russian monopoly refused, claiming they do not have the technical capabilities for it, which is not true since Gazprom had previously increased supplies through "Sudzha," whose capacity is 244 million cubic meters per day.

As a result, Gazprom simply refused to pay for the transit of 32.6 million cubic meters of gas per day in full. Considering that the daily volume for payment under the "take or pay" contract conditions was 109 million cubic meters, Naftogaz's losses amounted to 30% of the required amount.

Risks of transit halt for Europe and Ukraine

The probability of transit termination is considered quite high by experts and officials. Oleksandr Kharchenko, the Director at the Energy Industry Research Center, spoke in an interview with RBC-Ukraine about the possibility of transit termination a month before Miller's statement. "It is more likely that gas transit through the Ukrainian gas transportation system will be physically stopped. I fully admit that this may happen," he said in early June.

Energy Minister Herman Halushchenko stated that Ukraine is already preparing for a reduction in transit gas supplies. He finds it challenging to imagine the contract being extended after 2024. Other interlocutors in the government estimate the possibility of transit termination at 80-90%.

The EU can survive the winter without Russian gas altogether. Commissioner for Energy Kadri Simson stated this in a comment to RBC-Ukraine. Earlier, the EU wanted to abandon Russian gas by 2027. However, a lot of work has been done in the EU last year to replace sources, and gas supplies from Russia have been reduced by almost two-thirds. Currently, Europe is well prepared for any development of events.

"Over the past one and a half years, we have been preparing and developing a strategy that will help us survive the winter completely without Russian gas if necessary," stated the EU Commissioner.

The EU's storage facilities are already filled to approximately 80%, and an Energy Platform has been created for joint gas purchases, with Naftogaz also joining in. "We are well prepared and ready for any scenario. The EU is united and we have reliable partners we can trust," the EU Commissioner said.

The stable situation, regardless of the developments, is confirmed by the fact that Gazprom's statement about the possibility of stopping the transit did not cause any significant market reaction. Unlike previous instances where such statements caused a sharp increase in gas prices, this time the price even decreased in the second decade of July, falling below 300 dollars per thousand cubic meters.

Moldova, which receives gas through Ukraine, will be able to arrange gas supplies either from Romania or via transit from Slovakia – last year, Moldova already made small purchases through the Budince point in Slovakia on the border with Ukraine. Moreover, Moldova has accumulated a certain gas reserve in Ukrainian storage facilities.

However, in the event of a transit stoppage, Ukraine will not be able to receive payment for transporting gas to Europe, which amounts to slightly over 100 million dollars per month, on average. Additionally, it will be necessary to reconfigure the operation of the GTS. Previously, during the heating season, gas for the eastern and central regions was taken from transit volumes on its way to the western border. The gas used on the way out of Ukraine was compensated for with gas lifted from underground storage facilities in the western part of the country. This arrangement was convenient and permissible under all existing agreements.

If there is no transit, gas for the eastern regions will have to be lifted from storage facilities and transported deep into the country, all the way to the eastern border. Although this is a more complicated process, there should be no problems in this case.

Representatives from the Ukrainian government assure that all mechanisms for the GTS have been tested and worked out under new conditions. "All operating modes under new conditions have been coordinated between the GTS Operator and "Ukrgazvydobuvannia" (the largest gas extraction company in Ukraine). Since last year, we have been coordinating all processes in case of transit interruption," a government spokesperson familiar with the preparation of the system for the heating season stated.

Furthermore, in January 2019, the GTS already operated under conditions of minimal transit, where gas supply to the eastern regions had to be provided using gas from storage. Additionally, the first experience of operating the GTS without transit occurred back in 2009 when Gazprom ceased transit due to the absence of a contract with Naftogaz.

Former Head of the GTS Operator, Serhii Makohon, does not see any risks in ensuring gas supply to Ukrainian consumers without transit. "Currently, consumption has dropped, and the system for the domestic market can work autonomously, lifting gas from underground storage or importing as needed," he said.

The additional gas costs for transporting gas to the eastern part of the country will be insignificant. "Large capacities of compressor stations are necessary for large volumes, such as for transit. Without transit, the need for compressor stations operating for gas pumping will significantly decrease, resulting in reduced gas expenses," Makohon noted.

However, in the absence of transit, the risks of damaging the compressor stations due to attacks increase. The gas pumping capacities will no longer be crucial for Russia, and they may start targeting the GTS's surface facilities with deliberate attacks.

Damaging the compressor stations, which creates pressure in the system, will lead to disruptions in gas supply to consumers. However, serious problems are unlikely to arise, according to Makohon. "Our system is quite flexible, and it has a significant safety margin – many branches for gas supply," he added.