Gas remains a hot topic for Ukraine

Ukraine has had a long and troubled history of relations with its northern neighbour Russia, and the trend shows no sign of going away as we move into the 21st century. Since the breakup of the Soviet Union one of the major bones of contention has been natural gas, at first over complaints of non-payment, and then arguments over pricing which several times degenerated into a complete embargo, and it seems to be an issue which refuses to die. For a while it looked as though the deal struck between the two countries’ presidents in January 2009 might have settled things, but it has not prevented Gazprom from continuing to try and exert pressure over Ukraine. Now that there is a far more pro-Russian government in power in Ukraine, Russia is talking actively of a merger between Gapzrom and Ukraine’s state gas company Nefetegas, something which the Ukrainian opposition fear would effectively be a Russian takeover of Ukraine’s gas industry, given the relative sizes of the two companies.
Ukraine’s elections in February this year have delivered a much more Moscow-friendly administration under president Viktor Yunokovych, and a flurry of deals between the two countries has resulted. But
Ukraine’s gas-based chemical producers, predominantly ammonia and urea based, have found themselves on the wrong side of the partnership, and have in the meantime have sent heir costs progressively squeezed as gas prices continue to rise and the government finds itself less and less willing to continue to subsidise them. The Ukrainian prime minister Mykola Azarov has said that he is considering a complete withdrawal of discounts to nitrogen producers in the second half of 2010. At the moment the import price for natural gas from Russia is running at $7.50/MMBtu, and the Ukrainian National Electricity Regulatory Commission is seeking to increase prices to as high as $9.10/MMBtu, going up to $9.70/MMBtu from October, which would put Ukraine very much at the wrong end of the industry cost curve, especially at a time when gas prices in the US are down to $4.00/MMBtu. The industry has tried to talk the government down to $5.40/MMBtu, but it seems to be a vain hope given the prevailing mood in the country. Ukraine’s ammonia sector had already effectively become a swing producer thanks to the gas price deal agreed in 2009, and it is now facing being priced out of the market completely.
Even if the government were inclined to subsidise the ammonia industry, it finds itself in a poor bargaining position. The financial crisis has hit the country very hard; last year the economy contracted by 15%, its worst performance since the fall of the USSR. Heavily reliant on steel exports, Ukraine suffered disproportionately from the global contraction in manufacturing. At the end of 2008 Ukraine went to the International Monetary Fund for a $16.5 billion bailout, but the money was withdrawn last year over allegations of broken budget promises. The Ukrainian government has been left with very little room for manoeuvre, and it has found that the IMG has also been calling for and end to its gas subsidies.
Russia and Ukraine have agreed that any merger between Gazprom and Neftegas should only proceed step by step, the first one being to produce a 50-50 joint venture company to run some of the assets of both countries, such as gas transit pipelines. If Gazprom does come to control Ukraine’s gas transmission, whether it might be able to offer a more favourable deal as a lifeline to Ukraine’s ammonia producers – perhaps in return for an equity stake as it has done in Russia – remains to be seen.