September 3, 2013

Breaking the “Natural Law” of Gas Deliveries. The Mechanism of the Reverse Flows in Ukraine and Europe

Reuters/Scanpix
Gas pipes are pictured at Oparivske gas underground storage in Lviv region September 30, 2014.
Gas pipes are pictured at Oparivske gas underground storage in Lviv region September 30, 2014.

With regard to Russia’s energy pipelines, there has long been a view that gas must flow from east to west. Of course, barring human intervention, gas—like water—merely follows the path of least resistance, whether for natural (or political, in the case of energy markets), reasons. As its European importers continue to find other alternatives, Russia has sought to intervene to ensure the continued observance of its “natural law” that gas will always flow from east to west. Yet thanks to the efforts of Ukraine, a country faced with a particularly difficult energy transit relationship with Russia, west-east flows are now a reality, with EU member states Germany, Poland, Hungary and Slovakia exporting gas in the reverse direction.

With regard to Russia’s energy pipelines, there has long been a view that gas must flow from east to west. Of course, barring human intervention, gas—like water—merely follows the path of least resistance, whether for natural (or political, in the case of energy markets), reasons. As its European importers continue to find other alternatives, Russia has sought to intervene to ensure the continued observance of its “natural law” that gas will always flow from east to west. Yet thanks to the efforts of Ukraine, a country faced with a particularly difficult energy transit relationship with Russia, west-east flows are now a reality, with EU member states Germany, Poland, Hungary and Slovakia exporting gas in the reverse direction.

At the moment reverse deliveries from Europe enter Ukraine at two points: Drozdovichy, on the Polish border, and Berehove, on the frontier with Hungary. In fact, for January-July 2013 Ukraine imported 0.92 billion cubic meters (bcm) via reverse flows, although this remains a small fraction of the country’s total gas imports (which were 12.07 bcm over the same period.).
Moreover, this mechanism has been successfully used inside the EU energy market as well. European countries are gradually beginning to reduce Gazprom’s monopolistic weight, actively approaching energy diversification building new capacities enabling reverse transportation of gas and revamping existing infrastructure. All these measures are being taken in the face of strong Russian opposition, as the Kremlin views the reversal mechanism to be illegal.
Yet despite such political rhetoric, Ukraine does indeed have a realistic chance of meeting part of its gas demand via reverse gas imports. Indisputably, the step to commence reverse flows of the natural gas is a positive step forward. By cooperating with the EU on reverse deliveries, Ukraine is demonstrating a real commitment to achieve energy independence and establish a viable market for gas, building upon the gains it made in 2012—when it significantly liberalized its energy market, giving private businesses the right to import gas and sell it domestically.
The Western connection
Unfortunately, Ukraine still has yet to make much progress in improving corporate transparency, presenting a significant obstacle for prospective investors in its energy sphere. Moreover, the issue of corruption keeps European investors dubious about allocating funds towards modernizing the Ukrainian gas transmission system (GTS). Previously, the state company Naftohaz Ukrayiny held a monopoly on the import of gas from a single supplier Gazprom. However, at the moment, Naftohaz is aggressively moving into reverse-flow imports in line with recently established alternative trading companies, as discussed below. In May 2012, the company was the first to sign a contract on reverse deliveries, agreeing with Germany’s RWE to import 5 bcm in 2013 (with a possibility of an increase up to 10 bcm/year in the future) while continuing to purchase volumes from Gazprom according to the 2009 contract between the two parties. Nonetheless, Naftohaz remains obligated to import gas from Gazprom for both industrial and residential customers—a fact that has pushed the Ukrainian government to support the reverse mechanism in the first place.
Are Ukrainian oligarchs in the game?
Liberalization of the Ukrainian gas market eliminated import restrictions and ended the Naftohaz monopoly. Businessman Dmytro Firtash was the first to seize the opportunities provided by the liberalization, creating the energy intermediary Gas Trading AG OstChem, which was registered in Switzerland in December 2012. At the moment the venture is importing 8.1 bcm of Russian and Turkmen gas from Europe via reverse flows. However, Firtash (who formerly headed the scandal-ridden intermediaries EuralTransGas and RosUkrEnergo [RUE])—lacks credibility, having been labeled a pro-Russian “gas lobbyist” and “Russian agent of influence” in the past. He is thus unlikely to contribute effectively to Ukrainian gas liberalization; indeed, his latest initiative has been dismissed as a “take two” for the shadowy RUE.
Despite the questionable reputation of OstChem, the liberalization of the Ukrainian energy market has brought other players into the market for reverse supplies: VETEK and DTEK. The Eastern European Fuel and Energy Company (VETEK in its Russian-language abbreviation), formerly Gas Ukrayiny, specializes in sales of LPG and natural gas and petroleum products. The firm has already started importing gas from Europe via Hungary in March 2013 and plans to supply 1 bcm of gas from Europe by the end of the year, while the Donetsk-based energy holding company DTEK has just delivered its first supply of 0.1 bcm in July 2013. According to the latter the volumes would depend on the difference in price at the European hubs, the cost of extracted gas in Ukraine, and the technical capacity for cross-border flows from Hungary.
Beneficiaries and allies
Indisputably, the reversing of gas flows is a promising opportunity for Ukraine to become fully integrated into the EU energy market, including its natural gas spot market. In time, thanks to the country’s underground storage facilities on its western border (with a total capacity of 24 bcm/year), the country may become a gas hub for the entire region. Indeed, since the EU mandated bi-directional flow capabilities, reverse-flow arrangements have been rapidly implemented in other EU countries. For example, the German and Polish transmission system operators are now leading the process of developing reverse infrastructure at the Mallnow station along the Yamal pipeline. Thanks in part to these reverse-flow projects, Poland claims it will eventually satisfy 85% of its annual demand for natural gas from non-Russian sources.
These examples of successful bi-directional use of gas transportation facilities raise the hope that such measures can be used for energy diversification in the EU’s “energy islands” of Lithuania, Latvia and Estonia as well. However, the goal can be achieved over time by developing more interconnector facilities, eventually aligning their gas prices with European spot markets. Therefore, the gas interconnection project between Poland and Lithuania (GIPL) may allow Lithuania to access reverse flows via Poland at competitive spot market prices, delivering it onward to Latvia and Estonia—and Finland, if the deadlock over the location of the EU-supported LNG terminal can be resolved. As part of a coordinated program of focused infrastructure investments, then, this reverse-flow strategy can go a long way towards improving the energy security not just of one country, but of the entire region.
This article first appeared on the media portal Eastbook.eu in cooperation with ICDS’ Eastern Partnership research project.

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