ICIS EXPLAINS: What will happen after Ukraine’s gas transit contract expires?

LONDON (ICIS)–Ukraine’s five-year gas transit contract expires at the end of the year, raising questions over whether it may be extended or scrapped.

Although Ukrainian officials insist they would not negotiate with Russia as long as it continues its military aggression, some European companies which hold long-term contracts with Gazprom would like to continue offtaking the gas.

ICIS responds to questions that are currently asked by traders as they seek to forecast their market positions beyond 2024.

1. When does Ukraine’s Russian gas transit contract expire?

At 06.00am CET on 1 January 2025.

2. Will it be renewed?

It’s unlikely Ukraine and Russia would enter direct talks for a possible extension or renewal of the existing five-year contract.

Opening negotiations with Gazprom would be politically sensitive in Ukraine as long as Russia continues its military aggression.

Nevertheless, there is pressure from central European companies which hold either long-term supply or transit contracts with Gazprom to continue Russian shipments.

Ukrainian officials indicated the possibility of allowing companies to take the gas themselves at Sudzha on the Ukrainian-Russian border point.

Even so, the capacity can only be offered if an interconnection agreement is signed by gas grid operators for the Sudzha point on the Ukrainian-Russian border.

3. How much capacity could GTSOU make available?

The daily technical capacity at the Sudzha border point is 244 milion cubic meters (mcm).

The existing interconnection agreement stipulates that 87mcm can be booked daily on a firm basis.

Gazprom has booked 72mcm/day under the expiring five-year contract but uses only 42mcm/day currently.

In the absence of a renewed contract after 2024, European companies looking to extend imports may be able to book capacity on a spot basis as part of annual, quarterly, monthly or daily auctions. Companies could start booking annual capacity as early as 1 July 2024 but only subject to a new interconnection agreement.

4. Is there an indication how much capacity could be booked?

No. The minimal level where it is commercially viable for the gas transmission system operator, GTSOU, to provide transit services could be around 10 billion cubic meters (bcm)/year.

Although the current transit contract is for 40bcm/year, it is unlikely similar levels would be booked, considering that some countries such as Austria are working to diversify away.

5. What are the risks of booking capacity and transiting gas via Ukraine?

Risks are primarily linked to costs. Current transmission tariffs will expire at the end of the year and will have to be recalculated to reflect the new conditions following the expiry of the current transit agreement.

The cost of transit will reflect the level of interest in capacity bookings. However, it’s difficult to gauge interest since the first auctions for annual capacity are not held until July and so far there is no indication that there would be an interconnection agreement.

GTSOU and the regulator NERC are currently working on the new tariffs, reportedly using a no transit scenario.

6. How about war-related risk?

Russia has refrained from attacking the gas infrastructure since it started its full-scale invasion of Ukraine in February 2022.

Ukraine benefits from a vast network of pipelines, which would allow the rerouting of gas in case of attacks or accidents.

7. The Ukrainian gas network code says companies cannot book capacity with the grid operator if they have overdue debt. Considering that Gazprom is paying less than it is expected under its ship-or-pay contract, would this debt prevent it from renewing the transit?

No, the contractual arrangements are between Gazprom and the Ukrainian incumbent Naftogaz, which books the capacity on behalf of Gazprom.

Naftogaz initiated arbitration proceedings against Gazprom for paying less than contractually required. Gazprom owes Naftogaz $1.4bn for underdeliveries and sources close to GTSOU say no capacity should be allocated unless the Russian producer repays the debt.

Under contractual arrangements, Gazprom was expected to ship 65bcm/year in the first year of transit in 2020 and 40bcm/year for the remaining four.

However, in May 2022, GTSOU called force majeure amid fears gas entering via one of the two points that had been used for transit was diverted to Russian controlled territories. Gazprom closed the valve at the Sokhranivka interconnection point and GTSOU offered to reroute all flows via Sudzha.

Gazprom refused and reduced the amount of gas it was supposed to ship to Europe. For the last two years, flows entering Ukraine at Sudzha have hovered around 42mcm/day, compared to 109.6mcm/day, which Gazprom had booked to transit via Sudzha and Sokhranivka.

8. Can the Ukrainian transmission system operate if there is no transit?

Yes. The Ukrainian gas transmission system was initially built to operate from west to east as gas was supplied from the western parts of Ukraine to Moscow in the late 1960s. Flows were later reversed in the 1970s and the system has since then been used as the main transit route for Russian gas to Europe.

Ukrainian stakeholders were preparing to work without transit even before the expiry of the previous contract in 2019.

Domestic supplies are decoupled from transit and flows can be reversed from west to east.

9. Will storage injections and short-haul be affected if there is no transit?

Many companies have been relying on short-haul to inject gas in storage. This meant that rather than physically moving the transit gas to EU countries and then reversing it into Ukrainian underground facilities, it was directly sent into storage.

If there is no transit, the grid operators will have to provide physical reverse capacity.

The total physical capacity on Ukraine’s borders with Hungary, Poland and Slovakia is 54mcm/day but there are plans to expand it further.

GTSOU and the storage operator UTG have repeatedly invited companies to start injecting volumes earlier in the season to avoid congestion at the end of summer.

10. Who will be affected if there is no transit after 2024?

On a scale of least to worst affected, Ukraine would arguably rank at the lower end and the Transnistria, an unrecognised separatist province of Moldova, at the higher end. In between there are Russia and the EU countries that continue to hold import or transit contracts.

Ukraine will lose its transit revenue which stood at $800m last year and represented 0.46% of Ukrainian GDP. The money was mostly used to pay for essential operating costs and offset expenses involved.

In case there is no transit it will have to find other sources of revenue, including importing gas in reverse via the Trans-Balkan pipeline and decommission a large part of its transmission system.

Russia depends on Ukraine and Turkey to retain minimal market share and rebuild a stream of revenue which plunged more than 60% from €47.5bn in 2022.

EU buyers such as Austria’s OMV, Hungary’s MVM and Slovakia’s SPP whose longer-term contracts expire in the upcoming years have already indicated an intention to diversify away.

Slovakia’s gas grid operator Eustream has a ship-or-pay agreement with Gazprom which ends in 2028. Russia has historically relied on Ukraine and Slovakia to transit gas. If there is no transit via Ukraine, Gazprom may no longer see a point in paying for booked Slovak capacity.

Even though transit flows are currently a fraction of those contracted, Slovakia expects to be paid in full for the remaining four years. This means Eustream is one of the most interested parties in the renewal of the Ukrainian transit contract.

Finally, Transnistria continues to import 2bcm/year. Unlike Moldova, which has been able to secure volumes on European hubs, Transnistria is reliant on Russia for heavily subsidised gas deliveries. Diversifying away would mean paying for gas at market prices.