Russia-Ukraine: A Market Dispute
Are the Russians and Ukrainians simply fated to go to the mat every year about this time, causing grief to their neighbors? Or is something else at work in their antagonism?
The philosophical answer is that, while it's hard to imagine these two former Soviet states living as friendly neighbors any time soon, the current dispute is a separate matter.
It can be reduced to a difference of outlook: Do you expect oil prices to rise to $60 a barrel this year, or to drop back down to between $30 and $40 a barrel? (Oil has surged in the last two trading days to about $46 a barrel because of the fighting in Gaza.)
In Europe, natural gas prices follow oil, and Russia is clearly of the consensus view that oil will average somewhere in the neighborhood of $60 a barrel this year. That corresponds to a natural gas price of about $350 per 1,000 cubic meters. (Here's the loose formula to get the natural gas price: divide the oil price by six, then multiply the result by 35.3).
Hence the claim by Russian Prime Minister Vladimir Putin that the demand by Gazprom, Russia's natural gas behemoth, for $250 per 1,000 cubic meters from Ukraine this year amounts to a "humanitarian gesture."
Ukraine, however, has embraced oil's most recent price band. It's arguing that oil will average $40 a barrel this year, or $235 per 1,000 cubic meters of natural gas. That's precisely what Ukraine has counter-offered to Gazprom.
(As a separate matter, if Europe truly is paying $500 per 1,000 cubic meters, as Gazprom has claimed, it is seriously overpaying. That corresponds to $84-a-barrel oil.)
(Another baffling issue is Russia's claim that it's owed a $600 million late fee on top of the $1.5 billion natural gas bill that Ukraine already has paid. That's a 40% penalty, and Ukraine is only a month late.)
The subtext is the nature of the two countries' contract, which is based not on the spot price of natural gas, or a forecast, but a formula that lags current prices by eight months. In other words, when Gazprom is retorting that it in fact could charge Ukraine $418 per 1,000 cubic meters if it so wishes, that's Russia's estimate of the price of natural gas last May.
In the end, look for the two countries to settle some place in the middle, say at $50 a barrel oil, which would entitle Gazprom to charge $294 per 1,000 cubic meters. But don't be surprised if Ukraine bends a bit more toward Russia's demand than a down-the-middle compromise; indeed, I wouldn't be surprised if Ukraine agrees to Gazprom's offer of $250 per 1,000 cubic meters.
The dispute has more bite than previous rows because of the economic times. Ukraine is in an economic fix, as is Gazprom.
Regarding the latter, Gazprom's troubles go far. It doesn't produce much of the gas it ships to Europe, but markets gas it buys mostly from the Central Asian state of Turkmenistan. In order to obtain long-term rights to that gas, and not have it siphoned off by a covetous West, Gazprom has agreed to pay the Turkmen about $340 per 1,000 cubic meters.
Given market prices, that means that Gazprom might be forced to sell to Europe this year at a loss, unless it unilaterally cuts the price it pays to the Turkmen, who in that case could respond by withholding supplies.
"Gazprom is in a tough spot," says Kenneth Medlock, a natural gas expert at Rice University's James A Baker Institute for Public Policy, who helped me with the calculations for this article. If Gazprom loses the Turkmen supplies, Medlock said, "they are going to have trouble meeting their contractual commitments" to Europe.
The philosophical answer is that, while it's hard to imagine these two former Soviet states living as friendly neighbors any time soon, the current dispute is a separate matter.
It can be reduced to a difference of outlook: Do you expect oil prices to rise to $60 a barrel this year, or to drop back down to between $30 and $40 a barrel? (Oil has surged in the last two trading days to about $46 a barrel because of the fighting in Gaza.)
In Europe, natural gas prices follow oil, and Russia is clearly of the consensus view that oil will average somewhere in the neighborhood of $60 a barrel this year. That corresponds to a natural gas price of about $350 per 1,000 cubic meters. (Here's the loose formula to get the natural gas price: divide the oil price by six, then multiply the result by 35.3).
Hence the claim by Russian Prime Minister Vladimir Putin that the demand by Gazprom, Russia's natural gas behemoth, for $250 per 1,000 cubic meters from Ukraine this year amounts to a "humanitarian gesture."
Ukraine, however, has embraced oil's most recent price band. It's arguing that oil will average $40 a barrel this year, or $235 per 1,000 cubic meters of natural gas. That's precisely what Ukraine has counter-offered to Gazprom.
(As a separate matter, if Europe truly is paying $500 per 1,000 cubic meters, as Gazprom has claimed, it is seriously overpaying. That corresponds to $84-a-barrel oil.)
(Another baffling issue is Russia's claim that it's owed a $600 million late fee on top of the $1.5 billion natural gas bill that Ukraine already has paid. That's a 40% penalty, and Ukraine is only a month late.)
The subtext is the nature of the two countries' contract, which is based not on the spot price of natural gas, or a forecast, but a formula that lags current prices by eight months. In other words, when Gazprom is retorting that it in fact could charge Ukraine $418 per 1,000 cubic meters if it so wishes, that's Russia's estimate of the price of natural gas last May.
In the end, look for the two countries to settle some place in the middle, say at $50 a barrel oil, which would entitle Gazprom to charge $294 per 1,000 cubic meters. But don't be surprised if Ukraine bends a bit more toward Russia's demand than a down-the-middle compromise; indeed, I wouldn't be surprised if Ukraine agrees to Gazprom's offer of $250 per 1,000 cubic meters.
The dispute has more bite than previous rows because of the economic times. Ukraine is in an economic fix, as is Gazprom.
Regarding the latter, Gazprom's troubles go far. It doesn't produce much of the gas it ships to Europe, but markets gas it buys mostly from the Central Asian state of Turkmenistan. In order to obtain long-term rights to that gas, and not have it siphoned off by a covetous West, Gazprom has agreed to pay the Turkmen about $340 per 1,000 cubic meters.
Given market prices, that means that Gazprom might be forced to sell to Europe this year at a loss, unless it unilaterally cuts the price it pays to the Turkmen, who in that case could respond by withholding supplies.
"Gazprom is in a tough spot," says Kenneth Medlock, a natural gas expert at Rice University's James A Baker Institute for Public Policy, who helped me with the calculations for this article. If Gazprom loses the Turkmen supplies, Medlock said, "they are going to have trouble meeting their contractual commitments" to Europe.
Labels: gaza, Gazprom, natural gas, poland, Putin, romania, rosurkenergo, Russia, Ukraine
8 Comments:
Mr. Levine:
Thank you for this excellent explanation, not available elsewhere, of the opaque and confusing affair that the Russia-Ukraine gas relations are. Your analysis suggest implications beyond those two countries. Will the Russians fight tooth and nail to keep a prehensile West's hands off the Turkmen gas? One more reason to take a dim view of Nabucco and the Trans-Caspian pies in the sky.
Hi Ondrey. Turkmenistan and Bulgaria are the region's unlikely key geopolitical states. Turkmenistan because of its gas and role as Central Asia's natural energy transportation hub north, west, east and south; and Bulgaria as Europe's natural hub to capture the Turkmen (and other former Soviet) natural gas, and ship it on to the rest of the continent.
So you ask -- will Russia fight tooth and nail to retain its hold on Turkmen gas.
The answer is yes. And the West will likewise continue trying to ship it into the Baku-Turkey Energy Corridor.
I wanted to add my thanks. I found your blog by Googling after feeling confused over mainstream news articles on the Gazprom - Ukraine dispute. This provides just what I wanted to know.
Mr. Levine,
I have a few follow up questions for you, if you do not mind.
You have said that Russia wants to charge Ukraine $418 now, because of its formula. The formula is "Russia's estimate of the price of natural gas last May". So if we take $418, divide it by 35.3 and multiply by 6, we get $71 for a barrel of oil. However, oil was at its records high last May/June. Thus, can you provide more details on this formula that you have mentioned in the article? Does that mean that Gazprom was estimating the price of oil around 70 bucks during that time? And lastly, why is this Gazprom's formula lags current prices by eight months and how come forecast is not used.
Please let me/us know if you have a moment. I thank you in advance.
Thank you Steve. Had no clue about the Turkmen connection. Haven't seen it in any of the mainstream coverage. I also did not know that the 600 mil penalty fees are largely bogus. And just for good measure, you give us a reliable Gas/Oil price conversion for free!!
So glad you're back.
Arvin
What about the sub-European transit fees that Russia pays to transport its gas exports to Europe over 950km of Ukrainian territory?
If Russia pays Ukraine only $1.7Mcm/100km — while Europe charges up to $3.5Mcm/100km — why should Ukraine pay $418Mcm for Russian gas?
Mr. Levine:
Thank you for this interesting analysis. Your clarification of the prize dispute between Gazprom and Naftogaz is enlightening. There is however one important factor that you haven’t considered in your analysis. One of the mayor points of dispute is also the prize for the transit of the gas trough the Ukrainian territory. If Gazprom wants world prices for gas, it follows naturally that Naftogaz would like world price for transport of Russian gas trough Ukrainian territory. Gazprom seems unwilling to accept Ukrainian position.
What is your view on this subject?
Sounds like getting Turkmen (and later Kazakh) gas into Europe bypassing Russia would be like killing three birds with one stone. Europe's energy security would be improved. Central Asia's independence would be strengthened. Finally, a damper would be put on the Kremlin's neo-imperialist ambitions in Ukraine and the Baltics.
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