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Thursday, October 30, 2014

Gas talks stall as Russia pushes for EU guarantees on Ukrainian gas payments

Update 11.50 30/10/14:
Reuters is reporting that an EU spokesperson has said a deal is "very close" and talks will continue today, as we note below. As we also say below, a deal is still doable and likely, the question remains whether any form of EU payment guarantee will be needed and if this can get sufficient support within the broader EU member states.


Despite another round of talks between Ukraine, Russia and the EU which ran late into the night yesterday the negotiations seem to have reached somewhat of a stalemate.

Earlier in the year the halting of gas supply between Russia and Ukraine (for Ukraine’s own use at least) was not seen as too big of an issue and it was hoped Ukraine would be able to leverage the combination of economic pain from sanctions and the Russian government’s reliance on commodities exports for funding to secure a relatively favourable deal. However, on the cusp of the harsh Ukrainian winter the power balance has steadily shifted and Russia has continued to hold firm and even broadened its demands.

What has been agreed so far?
Quite significant progress has actually been made compared to the starting point:
  • Ukraine has agreed to pay for previous gas supply at a price of $268.5 per thousand cubic metres. This means $1.45bn will be paid by the end of October and $1.65bn ($3.1bn total) by the end of the year. Ukraine’s Naftogaz has set aside $3.2bn in an escrow account to pay for this.
  • Going forward Ukraine will prepay on a monthly basis for its gas this winter at a price of $385 per thousand cubic metres. Russia has agreed to pay transit costs.
Russia has clearly shifted from its original price demand (at least with regards to back dated payments), but Ukraine has also compromised by agreeing to prepay and pay off existing debts.

What are the key sticking points?
There is really only one, but it’s a biggie. While Ukraine has proven that it can afford to pay off its existing debts there is much less certainty about its ability to prepay going forward.

We have noted before the significant downward spiral in the Ukrainian economy. While the fighting has calmed down to an extent, things are still far from normal, not least because the conflict has become frozen in the East with part of the country still de facto cut off.

Ukraine is now totally reliant on external funding from the EU and IMF. As we have seen in the Eurozone crisis the release of such funding is often more complicated than expected and creates a staggered cash flow linked to economic reforms. Such reforms should pick up following the election but remain tricky to implement in a country caught in the proverbial no man’s land in the sanctions war between Russia and the EU.

For these reasons Russia has continued to demand some form of explicit guarantee from the EU that Ukraine will be able to pay for the supplies over the winter – they are expected to cost around $1.6bn, though this could increase if the winter is particularly harsh.

Is a deal likely?
It’s looking difficult as this meeting was earmarked as the most likely one for a deal. Russia seems to be using this arena to flex its muscles given that it believes it has the upper hand. That said, the economic costs of sanctions and a falling oil price are creating problems for the Russian economy, though it’s not always clear whether economic logic is sufficient to alter Russian President Vladimir Putin’s position.

Getting explicit EU support for around $2bn to guarantee prepayment would be difficult. But, so far, the EU has been fairly supportive of Ukraine and may be willing to offer a more tacit agreement to provide further funding rather than outright underwriting of the payments. Furthermore, without a deal there will be a huge temptation for Ukraine to siphon off gas which it is transiting from Russia to Europe. This could cause Russia to halt all gas flow through Russia, something Europe is keen to avoid to say the least.

Talks are set to resume later today according to RIA Novosti. With all this in mind, and the fact that a deal remains in all sides' interests, we would think one could still be struck.

What are the lessons here?
Ultimately, this dispute is teasing out a key question for the EU in the wake of this crisis. It is becoming increasingly clear that Ukraine is economically devastated in the wake of the war and the sanctions. The offer of opening up markets in the EU is unlikely to be sufficient and the EU and IMF will have to face up to the fact that in the short and medium term they will probably have to offer significant amounts of cash to Ukraine to help stabilise its economy, currency and energy supply.

Putin is aware of how politically sensitive this is for the EU – it has just gone through a series of its own bailouts in the Eurozone crisis and now countries are being asked to stump up cash for a country which is not even a member (and is unlikely to be one for the foreseeable future, if ever). As with the sanctions, this narrative is likely to expose dividing lines within the EU and set the tone for the negotiations over the future of Ukraine.


Jesper said...

Doubtful if any lessons will be learned, the arrogance has been striking and the mistakes many. Arrogance and learning rarely come together....

One lesson that could be learned is that by taking sides in an internal dispute the tensions are increased. Police know that, but arrogant knowitalls will try to resolve the crisis while tempers are running hot and the resulting consequences are often disastrous.

Another lesson that could be learned is that if you're responsible for increasing tensions then you're also expected to accept responsiblity for resolving the resulting problems - like now, pay up or forever be seen as an irresponsible unaccountable troublemaker.

Failure to pay and guarantee (will result in paying, drop the pretense) the future debts will push the so called EU-friendly away.

The EU went all in. The resulting choice now is: Pay up or lose face.

Or maybe this lesson is more relevant:
When you create an external enenmy to get domestic support then you need to show competence in the crisis or you'll make the case for less power, not more (like now).

Rik said...

Excellent comment.

Ukraine was basically bust before the troubles started.
Add: incompetent government; loss of big parts of tax (The now Novorussia areas probably accounted for 20% of the taxrevenue);nobody investing; companies moving to their main market (Russia), lots of money spend on waepons.
Most of it easily to be foreseen.
Country simply cannot pay for its gas. Easily to be foreseen.

Getting involved in these negotiations. Basically not as an independent party, but seen as a backer of one of them.

While this gascard had already been played before.

Utter moronic.

What is more important is the fact that the Ukraine's economy isnot 'saved' by 20 Bn or something loans. Probably more like 10-20Bn annually to get things running again.

Issue is if you pay for this one (which you probably have to especially at this stage (early winterperiod)). You are close to having bought you a new Greece.

Would have been much better to do something similar as with ISIS. Except for the bombing, very expensive and highly inefficient. Let 2 dodgy parties fight each other and support (but not openly) the least dodgy one if it looks it is going to lose. A lot of people will be killed but it are not yours and they are troublemakers anyway.

jon livesey said...

"Ukraine is now totally reliant on external funding from the EU and IMF."

This comment set me thinking. Since the Soviet bloc broke up, Poland's economy has advanced strongly, while that of Ukraine mostly stagnated.

So, while we notice Ukraine's downward spiral today, maybe we should also be asking if an independent Ukraine was *ever* on a sustainable trajectory of growth. Could Ukraine ever have generated growth, crisis or no crisis?

If the answer is no, then the best thing Ukraine could do is await or even provoke a political crisis, in the hope of being taken over as an EU protectorate, and then gradually integrated into the EU economy.

I don't suppose we will ever really know the answer, but I am pretty sure that oligarchs who survived the Soviet system and made themselves rich would be smart enough to figure out how to pull this strategy off.

Anonymous said...

It has not gone quite right for them
has it, hoping the Brits will cough
up 2billion euros by the end of the month, that really was arragance, why not ask Elmar Brok to hand over
some cash, after all he seem to be very prominent when it all kicked off in the Ukraine, along with other
German politicians.

Average Englishman said...

This situation reflects typical EUSSR incompetence. "Whaaaaa! I poked the big bear in the eye mummy and it bit me!" - Duhhh.

The EUSSR guarantees will no doubt be made to save face in Brussels and oil the wheels of the mandarins' empire building and after all, they can always send the UK another cooked up bill to pay for it all if necessary can't they?

Edward Spalton said...

Well, Senhor Barroso once said that the EU was an empire and now it is becoming clear that its insane programme of perpetual expansion is costing very dear. Britain had to give up its empire because we couldn't afford it.

Yet it seems they want to make us pay for this one.

Ironically Mr Putin once made the Ukraine an offer which would have covered this and the EU would have had no need to put its sticky fingers in our pockets.