(Bloomberg) -- The future of gas transit through Ukraine is at a turning point. If a last-minute deal isn’t struck by Wednesday, billions of cubic meters in gas flows could come to a halt.
Ukraine is under mounting pressure from Slovak Prime Minister Robert Fico and a group of central European companies to keep gas moving from its eastern border with Russia into the European Union following the expiration of a transit agreement on Dec. 31.
Almost three years after the full-scale Russian invasion of Ukraine, Budapest and Bratislava still rely on cheap gas from Gazprom PJSC, undermining the EU push to cut reliance on Russian energy.
With three days to go before the Russia-Ukraine agreement runs out, rhetoric on all sides has sharpened. Ukraine’s President Volodymyr Zelenskiy earlier this week accused Fico of striking “shadow agreements” with Russian President Vladimir Putin. The Slovak leader on Friday threatened to halt power supplies to his eastern neighbor, a step Ukraine criticized.
To diplomats with knowledge of the talks, the escalation hasn’t come as a surprise. Past disputes over gas transit between the two former partners saw flows cut or reduced at short notice — and deals clinched at the very last minute.
Energy traders, industry leaders and politicians in Europe and elsewhere are still looking to the three leaders for signs of what might come next.
Zelenskiy has repeatedly stated that he won’t allow Russian gas, which benefits the Kremlin’s war machine, to transit through Ukraine after the current deal ends. He’s said that he would be open to transporting gas from countries other than Russia — an option that people with knowledge of the talks say isn’t completely off the table.
In making the decision, the Ukrainian leader must consider the need to protect the country’s 38,600-kilometer gas pipeline system. The network, among the world’s largest, has been spared attacks over the last three years as Russian gas has flowed though it. If that were to stop, the system might become a target for missile strikes, as gas storage facilities and power supplies have been. It would also create technical challenges that would make it difficult to heat homes across Ukraine during the winter.
“The issue of risks for Ukrainian infrastructure is reverberating in diplomatic discussions,” said Christian Egenhofer, senior researcher at the CEPS think-tank in Brussels. “It may prove a lifeline for Zelenskiy if he opts to allow for continued transit.”
At the same time, Egenhofer noted, “the gas talks will matter beyond Ukraine.”
For both Putin and Fico, the most profitable option would be for European buyers to continue purchasing gas directly from Gazprom. Russia would then remain in the EU market without having to share revenue with intermediaries, and Slovakia would save on additional transit costs, according to people with knowledge of the talks who asked not to be identified. Ukraine’s Ministry of Foreign Affairs said on Friday that talks are ongoing and a last-minute deal cannot be completely ruled out.
Before the war, the executive arm of the European Union helped broker transit agreements between Kyiv and Moscow. Now, because of the bloc’s efforts to diversify energy sources away from Moscow and expand renewables, the European Commission is staying out of negotiations. Instead, it has stressed that alternatives sources are available and the region’s gas storage levels are high.
In February, the EU’s executive arm will unveil a plan to further phase out Russian fossil fuels, which it says the Kremlin has turned into a political weapon. Its implementation hinges on member states: in addition to pipeline flows to Slovakia and Hungary, Russian liquefied natural gas is also shipped to ports in France, Belgium and Spain.
“The row over the Russian gas will worsen the wedge between EU members, aligning neatly with Russia’s interest in seeing European support for Ukraine fracture,” said Bota Iliyas, a senior analyst at PRISM, a strategic intelligence firm.
The end of gas flows through Ukraine will have a “negligible” impact on European gas prices, the commission said earlier this month, noting that markets have already priced in the end of the transit deal.
European gas prices rose 48% this year, in anticipation of supply cuts combined with rapidly depleting gas reserves due to periods of cold and windless weather. While costs are still far below the 2022 records reached during the energy crisis triggered by the first phase of the war, they’re high enough to impact households and manufacturers.
The absence of an intergovernmental agreement between Russia and Ukraine complicates but doesn’t rule out a commercial deal involving European companies. Slovakia’s gas utility Slovensky Plynarensky Priemysel AS and its gas network operator Eustream AS — alongside Hungary’s MOL Hungarian Oil and Gas Plc., trade associations and large industrial customers from Austria and Italy — have urged Zelenskiy to allow shipments to continue.
The volume being discussed is 15 billion cubic meters a year, the amount that currently moves through Ukrainian pipelines.
Following his meeting with Putin in Moscow a week ago, Fico said that Russia was ready to continue delivering gas to the West via Ukraine, but this would be “practically impossible” after Jan. 1 given Kyiv’s stance.
In response, Zelenskiy said he’d offered to compensate Fico for the additional costs that Slovakia would accrue should Russian gas transit end. He said he was also ready to allow shipments of non-Russian fuel if a request was to be made by the European Commission — an offer which he claimed the Slovak leader rejected.
The spat escalated further late on Friday, when Fico said in a video posted on Facebook that if the flows stop, he’ll assess potential reciprocal measures, including halting power supplies that Ukraine needs during its network outages. The end of transit of Russian gas would cost the EU an additional 120 billion euros ($125 billion) in energy costs over the next two years, according to Fico.
“Stopping the transit of Russian natural gas through Ukraine is not just a hollow political gesture. It’s an extremely costly move, one that we, in the European Union, will pay for,” Fico said.
Ukraine’s Energy Minister German Galushchenko hit back on Saturday, telling a local television station that he alerted the EU and the region’s energy community that a halt in power supply will violate European regulations. He added that Ukraine has mechanisms to substitute Slovak electricity with more imports from other partners.
With the deadline approaching, alternative solutions are being considered. SPP has been in talks with Azerbaijan’s state-owned oil company about sourcing Azeri gas, according to people with knowledge of the talks. That may require a swap between Gazprom and Socar, in which the Azeri company would purchase corresponding volumes from Russia to deliver to European buyers.
Hungarian Prime Minister Viktor Orban has also proposed moving the location of Russian gas sales to the physical border between Russia and Ukraine, which would transfer gas ownership to European buyers and oblige Ukraine to ensure transit under its free trade agreement with the EU, according to people with knowledge of the issue.
Putin acknowledged various proposals on Thursday that would allow Hungary, Slovakia, Turkey or Azerbaijan to take control of the gas shipped through Ukraine. He noted that any such arrangement would be difficult to enact because of Gazprom’s long-term contracts.
Before the invasion of Ukraine in February 2022, Russia was the EU’s top gas supplier, providing more than 40% of the bloc’s imports. Following the outbreak of the war and a cut in supplies, Europe accelerated its shift away from Russian energy. Last year, Russian gas made up around 8% of EU imports.
Permitting further Russian gas to transit through Ukraine would undermine the message that the EU can no longer do business as usual with Putin’s Russia, said Benjamin L. Schmitt, senior fellow at the CEPA think-tank and the University of Pennsylvania’s Kleinman Center for Energy Policy.
“The stakes couldn’t be higher,” Schmitt said in a research note. “Continuing Russian gas transit in any form — whether through an overt contract extension with Kremlin-controlled Gazprom, or under any other name, but still de facto Russian — would be dangerous for Ukraine.”
--With assistance from Daryna Krasnolutska and Daniel Hornak.
(Updates with Ukrainian energy minister’s comments from the fourth paragraph)
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