It seems to be going horribly wrong for Ukraine regarding gas supplies from Russia.
Russia and Turkey have reached agreement over the South Stream pipeline traveling through Turkish waters, a matter that was the only thing preventing its going ahead.
With Nord Stream on line already, pumping Russian gas directly to Germany and bypassing Ukraine, it seems extremely likely that South Stream will be on line by 2015 pumping gas directly from Russia to Italy, again bypassing Ukraine.
Whilst the EU’s Nabucco pipeline looks unlikely, a cheaper version seems likely to get the go ahead supplying gas from the Caspian Sea directly to the EU again completely avoiding Ukraine. Which cheaper version remains to be seen as there are several being considered.
The net result seems now very likely to be that there will be 3 gas pipelines from eastern producers to end user avoiding Ukraine and may well be the most costly economic legacy of the Yushenko era.
The options to keep the Ukrainian GTS (gas transport system) relevant to both Russia and the EU seem to be narrowing dramatically and the window of opportunity to save its relevance closing at an alarming speed if you happen to be in the Ukrainian government.
Not a particularly strong position to be in when asking for a $9 billion per annum discount from the current crippling contractually agreed price structure.
Even during her flawed trial, when asked what she would have done had she won the Presidential election in 2010, having authorised such a bad agreement, she stated she would have tried to renegotiate it thereafter. Sadly for her she lost and never got the chance.
To be fair to Ms Tymoshenko, when she authorised the agreement, there was an election on the horizon, the EU was piling on the pressure to get the taps turned back on and Russia had won the media war as to who was at fault for the taps being turned off in the first place.
It would have taken a very strong leader to not have buckled under such pressure and in such circumstances. Ms Tymoshenko is a populist politician by nature and always has been. Populism is not something normally associated with making strong and unpopular decisions, particularly with an election on the horizon. Whether any other past, present or future Ukrainian leader would have made a different decision or would have caved in, we will never know.
The net result however, is a gas price that is completely unsustainable as far as the Ukrainian economy is concerned unless the price of gas for the Ukrainian population is raised significantly. At present it is heavily subsidised by the government, just as all previous governments have done.
The raising of the gas price to consumers is a key IMF demand but the political will to do this is lacking given there is a parliamentary election in October this year. The personal economics of the voter will be a significant driver at these elections just as they will be for Presidents Sarkozy and Obama.
Asking for a $9 billion discount from Russia during the run up to an election is not good timing either. Despite what western media likes to state, Party of Regions and President Yanukovych have never really been as friendly to Russian interests as has been portrayed.
Whilst there is talk of several joint ventures between Gazprom and Naftogaz Ukraine, the recent full and unconditional surrender to Gazprom of the Belorussian State gas company does not bode well for a friendly conclusion to the current negotiations for cheaper Russian gas.
To be fair to the current government, it seems to be doing all it can to avoid gifting Gazprom 50% (or more) of Naftogaz Ukraine. This year it will half the amount of Russian gas imported and step up domestic production whilst also trying to increase energy efficiency. Whether that will be enough to off-set the Russian gas they will not import remains to be seen.
It certainly seems very unwilling to give up ownership of the Ukrainian GTS unless any such surrender is in a troika with the EU as well. Producer, end users and transporter. That seems increasingly unlikely given the direct importation systems now working, under construction or under consideration. After all, each pipeline avoiding Ukraine has EU stakeholders in the projects with Gazprom.
In the short term, should the current government refuse to give up the GTS, it could very well end up transporting very little if anything to the EU. In the long term, once the Black Sea Shelf explorations get underway, Ukraine will need it as it moves from net gas importer to net gas exporter should production allow.
A very hard choice is upon the immediate horizon for the current government and a choice that will have many detractors regardless of what decision is made. At most there is another 12 months before this decision has to be made one way or another should there be no beneficial agreement with Russia that somehow results in cheaper gas but holding onto ownership of the GTS.
Even if Ukraine could produce all its own gas requirements inside the next few years (which is impossible) it is still tied to pay for a significantly high cubic meter minimum amount of gas from Russia as per the contract agreed by Ms Tymoshenko. Use it or not, Ukraine would still have to pay.
What has this got to do with the Ukrainian currency devaluation?
In the first six months of 2012, Ukraine has a large amount of foreign debt due. Some will get refinanced and some repaid but this, the NBU’s interference in the currency markets to keep the UAH at around UAH 8 - $1 and the unsustainable current price Ukraine pays Russia for gas, will drain the foreign reserves.
If the Russian position does not soften, by the year end there will not be sufficient funds to actively interfere in the currency markets to keep the UAH stable.
Undoubtedly no UAH devaluation will occur before the October elections but it seems currently implausible that we will get to the end of 2012 without the UAH devaluing to UAH 10 or UAH 11 to the US$ (assuming there is no dramatic change in the circumstances of the US$).
Gas and currency devaluation - one to keep your eye on in Ukraine during 2012.