What will Russian sanctions against Naftogaz Ukrainy lead to?

Press Secretary of the President of Russia Dmitry Peskov on July 7 confirmed the possibility of Russia imposing sanctions against Naftogaz Ukrainy. On the eve of such restrictions by the Russian authorities, the chairman of the board of Gazprom, Alexei Miller, spoke.

“Certainly. This was a fairly well-reasoned statement by the head of Gazprom. The reasons why such a possibility is not ruled out were outlined there,” Peskov said. He did not name the possible timing of the introduction of restrictions, adding that everything will depend on the situation. Peskov stressed that Russia would not allow “to infringe on our interests or interests [российской] companies.”

Miller complained on July 6 that Naftogaz continues to try to organize “bad-faith litigation regarding the transit of Russian gas to Europe.” The Ukrainian company itself, according to the top manager, violates contractual obligations to Gazprom.

Attempts by Naftogaz to continue the proceedings in arbitration, according to Miller, speak of an unconstructive attitude towards organizing the transit of Russian gas and a hostile attitude towards Russia. “If such unfair actions of Naftogaz continue, it cannot be ruled out that this may lead to the imposition of sanctions by the Russian Federation. Then any relations between Russian companies and Naftogaz will simply be impossible,” Miller said.

Ilya Zharsky, managing partner of the Veta expert group, notes that the imposition of Russian sanctions will automatically terminate any obligations of Gazprom to Naftogaz. But Naftogaz and European partners can file lawsuits against Gazprom.

A similar situation has already blocked the possibility of deliveries through the Yamal-Europe gas pipeline. In May 2022, by decree of Russian President Vladimir Putin and a government decree, sanctions were imposed against a number of companies, including against the owner of the Polish section of the Yamal-Europe gas pipeline, Europolgaz. The prohibition concerns transactions and payments in respect of persons under sanctions.

In September 2022, Naftogaz of Ukraine filed a lawsuit against Gazprom with the International Arbitration Court of the International Chamber of Commerce in Paris (the proceedings will be held in Zurich, Switzerland). The court accepted it for consideration, reported “Gazpromin March of this year. In the lawsuit, Naftogaz demands payment for “unproven services” for gas transportation.

The former chairman of the board of Naftogaz, Yuriy Vitrenko (he held the post until November 2022), explained that the lawsuit concerns the underpayment of Gazprom for the capacities of the gas transmission system (GTS) of Ukraine booked for transit. The amount of claims considered by the arbitration was not named.

Alexey Gavrishev, Managing Partner of AVG Legal, points out that, according to European law, the suspension of obligations in response to a delay in their reciprocal execution is a “normal way of protection”. “Naftogaz is acting in bad faith, so in this case the arbitration should take the side of Gazprom,” the lawyer believes. The decision of the European Court is unpredictable, Zharsky believes. “The court will be in Zurich, and Switzerland has become one of the unfriendly countries, which in theory can deprive “Gazprom“the right to a fair trial,” he believes.

In addition, at the end of June 2023, Naftogaz and five subsidiaries of the Ukrainian group applied to the District of Columbia court in the United States with a demand to enforce a court decision to recover $5 billion from Russia in another lawsuit related to the loss of assets in Crimea.

Under the current contract with Naftogaz, from 2021, Gazprom must annually pump 40 billion cubic meters through the Ukrainian GTS. m of gas (approximately 109.5 million cubic meters per day) under the “pump or pay” condition. Under the terms of the agreement, Gazprom must pay approximately $1.25 billion a year for transit. The contract signed at the end of 2019 expires at the end of 2024.

In May 2022, Ukraine refused to accept applications for pumping gas through the Sokhranovka gas measuring station (GIS) in the Rostov region, from where gas is supplied to the territory of the Luhansk People’s Republic. Now transportation is carried out only through the Sudzha GIS in the Kursk region, from where the fuel goes to the Sumy region controlled by Ukraine. At the beginning of May 2022, Gazprom exported 92–99 million cubic meters in transit through Ukraine. m of gas per day, after the blocking of applications for the GIS “Sokhravovka” pumping fell by more than half to 41-43 million cubic meters. m per day. At the beginning of July 2023, deliveries averaged 41.9 million cubic meters. per day.

The export of Russian gas to Europe is now carried out only along two routes – in transit through Ukraine and along one of the two branches of the Turkish Stream. Through the Turkish Stream (the capacity of each of the two branches is 15.75 billion cubic meters per year), gas is supplied to Bulgaria, and then through the Balkan Stream gas pipeline to Serbia, Hungary, as well as to Greece, Romania, North Macedonia , Bosnia and Herzegovina and Croatia.

In transit through Ukraine, gas is delivered to Hungary and Slovakia, and then to the countries of Central and Western Europe. According to Sergei Kaufman, an analyst at FG Finam, the main buyers of gas along this route are Hungary, Austria, Italy and Slovakia. Igor Yushkov, a leading analyst at the National Energy Security Fund, adds that Russian gas is also supplied through it to the Czech Republic, Germany and France.

Moldova also receives gas via the Ukrainian route. But Gazprom can also supply gas to this country in reverse mode through the Trans-Balkan gas pipeline (passes through the territories of Romania and Bulgaria to Turkey).

Kaufman recalls that Italy, as previously stated by the energy company Eni (the country’s key gas purchaser), may refuse Russian fuel only after two years, and Austria only by 2027. These countries are counting on the import of liquefied natural gas (LNG) to Europe , he explains.

According to Kaufman, in the case of a cold winter in 2023/24. without supplies from Russia in the countries of Central Europe, there may be a shortage of gas. Senior analyst “BCS The world of investment” Ronald Smith admits that a shortage is possible even if the transit of Russian gas remains at the current level.

Analysts note that the current level of transit through Ukraine corresponds to about 15 billion cubic meters. m per year. With a gas price of $350-400 per 1000 cubic meters. m (current spot prices in the EU), which corresponds to $5.3-6 billion in Gazprom’s revenue, or $3.7-4.2 billion after export duty.

Gazprom’s revenue under IFRS in 2022 increased by 14% to RUB 11.7 trillion, gas export revenue (before export duty) increased by 28.1% to RUB 7.3 trillion. The company’s net profit decreased by 41.4% to RUB 1.3 trillion.

Gazprom has virtually no options for compensating these revenues, experts say. Smith explains that the Power of Siberia-2 gas pipeline (through which Gazprom’s gas should go to China. – Vedomosti), even if an agreement on it is signed right now, will work “at least in four years.” Turkish Stream is operating at near capacity, Smith continues, Nord Stream is damaged, and Nord Stream 2 is unlikely to be launched any time soon. It is impossible to restart the Yamal-Europe gas pipeline through Poland due to the sanctions imposed by the Russian authorities, he adds.

If the EU is ready to buy gas from Gazprom through a gas hub in Turkey (a promising project discussed by Moscow and Ankara – Vedomosti), expanding the capacity of Turkish Stream may be the preferred option, Kaufman adds. But Kirill Rodionov, an expert at the Institute for the Development of Technologies in the Fuel and Energy Complex, does not exclude that Turkey may become a competitor of Gazprom in the EU market in the near future due to gas production at the Sakarya field (the design level of production is 40 million cubic meters per day).

Smith and Kaufman believe that for economic reasons, stopping transit through Ukraine in 2023 is unlikely, but possible after the completion of the current transit contract in 2024. Kaufman does not rule out force majeure due to hostilities. Yushkov admits that it is possible to talk about stopping transit after the end of the 2023/24 heating season.

Vedomosti sent inquiries to Gazprom and the Ministry of Energy of the Russian Federation.