As Court Battle Ends, Energy Dispute Between Ukraine And Russia Escalates
12 March, 2018

The four year battle between Ukraine’s energy giant Naftogaz and Russian state-owned Gazprom came to an end last month, with the Stockholm arbitration court ruling in favor of the Ukrainian gas company.

The court backed Naftogaz in its claim that Gazprom failed to deliver the agreed upon gas volumes for transit through Ukraine to Europe, causing $4.63 billion in damages.

But this has not been a straightforward victory for Ukraine and, since then, the dispute has only escalated. Over the past week, Gazprom canceled energy supplies to Ukraine amid freezing temperatures and announced intentions to terminate existing contracts with Naftogaz.

How did it start?

In 2014, amid mounting political tension between the two countries – culminating in the outbreak of the war in Donbas and Russia’s illegal annexation of Crimea – the two sides took a string of claims against each other to the Stockholm arbitration court.

Gazprom accused Naftogaz of failing to honor a controversial 10-year ‘take-or-pay’ contract, which bound Ukraine to paying for more than 50 billion cubic meters of gas annually – whether or not it was consumed – at what many say were inflated prices.

Meanwhile, Naftogaz claimed that Gazprom under-delivered on the agreement to pump 110 billion cubic meters of gas a year through Ukraine to Europe. It also asked the court to review the price on gas purchased between 2011 and 2015 and gas volumes outlined in the ‘take-or-pay’ contract.

In a ruling handed down last year, the Swedish court revised the terms of the ‘take-or-pay’ clause, obliging Naftogaz to only purchase five billion cubic meters of gas from Russia annually. It also ordered Naftogaz to pay Gazprom $2 billion in gas supply arrears – a far cry from the $56 billion Gazprom had sought.

Then, in February, the court ruled in favor of Naftogaz, determining that Gazprom under-delivered on transit gas, which cost Naftogaz $4.63 billion. As a result, Gazprom was ordered to compensate Naftogaz $2.56 billion in damages.

Although Gazprom confirmed its commitment to paying the $2.56 billion, the Russian gas monopoly stated that it did not agree with the court’s decision.

Kyiv, meanwhile, is skeptical of Russia’s intentions to comply with the Stockholm court’s ruling and, according to reports, has started seizing Gazprom’s assets in Ukraine and searching for its foreign assets.

Mounting tensions

It didn’t take long for Gazprom to show its displeasure with the Swedish court’s decision. On March 1, the Russian energy company canceled a prepaid gas delivery to Ukraine. It was supposed to be the first gas supply from Russia in more than two years.

The unexpected energy shortage forced Ukraine to reduce its gas consumption by 14%, despite the sub-zero temperatures. Schools and universities were even advised to close until March 6 in a bid to preserve energy supplies.

In a statement, the CEO of Naftogaz Andriy Kobolev said that they were “surprised” by Gazprom’s decision not to restart gas supply to Ukraine, adding that Naftogaz “regard Gazprom's refusal to supply as a breach of contract and failure to comply with the decision of the arbitration.”

In the meantime, Ukraine sought assistance from its European partners. On March 2-3, the European Commission held consultations with both Ukrainian and Russian sides, and Ukraine signed a gas deal with Polish gas company PGNiNG to help with the deficit.

On March 4, Ukrainian President Petro Poroshenko announced on Twitter that the situation had stabilized.

"Today we have a stable gas supply situation: we have enough gas in storage facilities, gas production, and imports. We have a sharp increase in the supply of gas from the EU, from Poland, Slovakia, Hungary. The deficit is currently completely covered," he wrote.   

However, Gazprom did not stop there. On March 3, the Russian company announced that it intended to terminate its contracts with Naftogaz. The Deputy Chairman of Gazprom’s Management Committee Alexander Medvedev stated that the company was referring the issue back to the Stockholm court to be considered by another panel of arbitrators.

In a briefing on March 5, Naftogaz Commercial Director Yuriy Vitrenko announced that they had received official notice of Gazprom’s plans to terminate the contract and expressed the company’s opposition to Gazprom’s actions, stressing Ukraine’s importance as a gas transit country.

“We can note that it is very important for us to preserve the transit of gas through the territory of Ukraine and the supply of gas to both Ukrainian and European consumers. Therefore, any actions that will threaten this will not be supported by our side," Vitrenko stated.  

Vitrenko also pointed that, contractually, Gazprom only had the right to appeal for arbitration 30 days after the ruling, adding that the litigation for the case could take years.

On March 5, Naftogaz also announced that it would be shutting its only Russian office, located in Moscow. The Naftogaz supervisory board ordered the Moscow office to make all the necessary arrangements to liquidate the office by March 12.

What does this mean for Ukraine and Russia?

Despite Gazprom’s threats to cancel its contracts with Ukraine, analysts believe it’s unlikely that the Russian gas giant will succeed.

East European Gas Analysis managing director Mikhail Korchemkin says Russia is currently unable to fulfill all of its gas contracts in Europe without using Ukraine as a transit route.

“The loss of this [case] not a force majeure, it's not an excuse to break contracts with western partners, no matter what Gazprom's relations with Ukraine and Naftogaz,” he said.

That, he added, would also portray the Kremlin-controlled company as an unreliable supplier. It’s a reputation that the company has already earned among some European Union member countries.

In an op-ed from the Polish Oil and Gas Company, published by pan-European media network Euractiv, the company claimed that “Gazprom had a long history of restricting supplies if the market does not respond ‘properly’ to its demands (or threats).” Moreover, it stated that gas supplies to Poland have been disrupted six times since the country joined the EU.

Roman Nitsovych, a program manager at the DiXi group energy think tank, believes that Russia’s actions are merely a case of dragging their feet in the wait of a more favorable climate to come to Ukraine.

“[Russia] wants to drag us into another arbitration, which [they hope] will last until the [Ukrainian] government changes to a less reluctant position,” he told Hromadske.

But Korchemkin says this is a temporary escalation of tension, which will “pass over with the election in Russia” and with the end of the heating period, “which is also very important.”

“In summer, normally relations are good because it doesn't make sense to cut or reduce gas flow to or through Ukraine in the summertime.”

/By Natalie Vikhrov and Sofia Fedeczko