By JEROME GUILLET
The Wall Street Journal
New York, New York
Friday, November 8, 2002
The recent announcement by Russia and Ukraine that they were creating a
joint enterprise to jointly manage the export gas pipelines going through
Ukraine -- from Russia to Europe -- has struck fear in the hearts of many.
Ukrainians are afraid that their country's newly achieved independence will
end with their main enterprises taken over by the Russians. Russians are
worried that they are going to end up paying for the pipeline maintenance
not done by their poorer cousins in Kiev; and Western Europeans worry about
the reliability of their gas supplies from the former Soviet Union. The
reality is quite different.
The fate of Ukrainian gas pipelines has long been an object of concern for
followers of the gas industry in Europe. Ninety percent of Russian exports
to Europe must go through them, and Ukraine has been regularly accused of
siphoning this gas. Yet this accusation has been true in only three well
publicized incidents, in 1992 and 1993.
What happened back then was very simple: Russia tried to cut off its gas
deliveries to Ukraine, which were not being paid for, and Ukraine retaliated
by reducing deliveries on the export lines to Europe. This situation lasted
only a few days; in each instance, Western buyers immediately panicked, then
Russia backed off and resumed supplies to Ukraine. But deliveries to Europe
have not been interrupted a single time since 1993.
Gazprom understands very well that the reliability of its supplies is
essential in its relationship with European purchasers, and it took the
decision then to deliver to Ukraine whatever was necessary to get the
exports out on the other side. Indeed, this situation was really no worse
than what was happening elsewhere in the region, with gas delivered and not
paid for -- except that no other customer of Gazprom held a stranglehold on
the company quite like the Ukrainians did.
Luckily for Gazprom, no other customer was also quite so bumbling. The only
thing that the Ukrainians managed to achieve in return for controlling
absolutely 25% of Russian exports was a dwindling supply of gas, which was
wasted with the same abandon as in the Soviet period. No reforms were
engaged to reduce consumption, or to try to grab the export market from
Gazprom by buying the gas from them and on-selling it to Europe. Instead,
the Ukrainians let Gazprom slowly take over their industry.
Corruption in the Ukrainian gas industry meant that certain officials took
advantage of Gazprom's inability to enforce payment in order to enrich
themselves. As in Russia , the final consumers in Ukraine quite often paid
for their gas, but the bill collector chose not to pass on these revenues to
Gazprom (in Russia for political reasons, and in Ukraine thanks to control
over the export routes).
Gazprom's brilliant solution was to have Russian gas delivered by someone
else, a private entity not affiliated to Gazprom which could cut off
supplies to Ukraine without risking retaliation like Gazprom: Itera. Itera
found accomplices among Ukrainian factions able to take control of the gas
distribution business, and it sold directly to such private entities and not
to Kiev's state gas company.
Gas was procured by Itera from Turkmenistan to build the fiction that it was
not Russian gas being delivered (a scheme made all the easier because
Turkmenistan was in such a weak bargaining position, with all its pipelines
going straight to Russia ). The revenues collected in Ukraine from
distribution of non-Gazprom gas -- whether in the form of money, goods or
ownership of local production assets -- were shared between the new
Ukrainians, Itera and its partners in Russia and Turkmenistan.
The fact that Itera, and Itera alone, was able to ship large volumes of gas
through Gazprom's pipeline network between Central Asia and Ukraine strongly
suggested to observers that it had close relations with Gazprom's top
management, although this has always been denied by both Gazprom and Itera
and never has been conclusively proven by outsiders. In any case, such a
sort of arrangement seemed to make sense: It reduced Gazprom's deliveries to
Ukraine and extracted some revenue for Gazprom from that country (whatever
was paid by Itera for gas transport which would have taken place anyway) and
it was a perfect opportunity for well-connected individuals to benefit. This
led to massive corruption and nasty political battles inside Ukraine, to
take part in this juicy business, with the population, as usual, the main
Meanwhile, as Itera officials stepped in with its deliveries, Gazprom's
deliveries were quickly reduced to a volume of 25-30 billion cubic meters
per year, which is the volume where Gazprom loses no money in Ukraine,
because the value of that gas roughly corresponds to a reasonable transit
tariff payable to Ukraine for all the volumes exported to Europe through
Ukraine, which is some 120 bcm a year. Ukrainians still do not pay for that
gas, but they do not incur new debts (the $1.4 billion debt figure quoted
all the time is essentially the debt incurred in 1992-93 which is
rescheduled every other year.) Gazprom does not get cash but gets value for
its gas. This can be accounted at production cost or at any equivalent
transit tariff value, depending on the reporting requirements of the day --
the difference between the two extreme options can represent an extra $2
billion per year in Gazprom's declared revenues and profits.
Today, Ukraine receives 50 bcm of gas per year from, or, in the case of
Turkmen gas, through Russia (compared to close to 100 bcm in 1990). Half of
it is delivered by Gazprom directly, the other half by Itera or other
similar "independent" traders. Gazprom's exports flow to Europe unhindered,
with plenty of spare capacity (thanks to deliveries to Ukraine having fallen overall faster than Gazprom's exports to Europe have grown), and its
deliveries to Ukraine bring it a decent level of revenue.
So, why would Gazprom want to bother now taking over the assets? The simple
explanation is that it represents a great opportunity to make the European
purchasers pay for the maintenance of the Ukrainian pipelines. Gazprom has a
long history of making its clients pay, willingly or not, for its
investments. For instance, Ruhrgas purchased shares in Gazprom at a time
when nobody wanted to invest in Russia , in exchange for the shelving of
Gazprom's expansion plans in Germany (via its Wingas venture with BASF). The
Italian energy company ENI invested in the Blue Stream pipeline, which
significantly increases Gazprom's export capacity to Turkey, at the same
time that Gazprom's plans to develop in Italy with Edison were abandoned.
This time, the idea is to build on the bad reputation earned by the
Ukrainians (since "thieves" wouldn't bother to maintain their pipeline
network) to once again get the likes of Ruhrgas, ENI and Gaz de France to
pay for new Gazprom investments. After all, even if they pay for truly
needed work in Ukraine, it frees Gazprom resources for other projects.
In sum, while the "Russian-Ukrainian condominium" name may make it sound
like a collective venture for the good of Europe, it really is closer to
highway robbery. But the Western companies can't do much about it. The share
of Russian gas is bound to increase inexorably in Europe in the coming 20
years as demand grows and all buyers need to renew their contracts and
safeguard their supplies. Still, it would be ironic if, by agreeing to pay
Gazprom to maintain its transportation infrastructure and reduce its
dependency on (supposedly unreliable) Ukrainian partners, Western European
companies end up strengthening Gazprom's overall control over the European
gas market by way of its iron grip on the main transport routes.
Gas is essentially an infrastructure business, and Gazprom understands this
better than most and has been building up and nurturing its access to the
European market steadily over the past 30 years, as the Ukrainian saga
attests once more. Other gas companies, beware; before it is too late.
Mr. Guillet is an investment banker in Paris, and has worked with Gazprom in
the past. Write to Jerome Guillet at email@example.com
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