After almost sixty years, the continuation of transit of Russian natural gas across Ukraine to the European Union is no longer guaranteed. Russian gas first flowed through Ukraine and on into Czechoslovakia before reaching Austria in September 1968, but now, under the current 2019 contract and if no new agreement comes into force, that arrangement is set to expire on 1 January 2025. Although the transit flows have progressively fallen over the last decade to just 15bcm, the Ukrainian transit capacity remains immense. Ukraine has a nameplate export capacity of over 150bcm. However, the geopolitical, technical, economic, and legal pressures at play now make it very difficult to see how any transit across Ukraine can be sustained.
Download and read as a PDF: The End of the Affair? The Transit of Russian Gas Across Ukraine
The State of play
Historically, Ukraine provided the only transit route for Soviet and then Russian gas to European states in what became the European Union. A dense network of pipelines across Ukraine permitted up to 150bcm of Russian gas to be exported westward. This supply system was also underpinned by over 30bcm of storage facilities in western Ukraine. However, post the fall of the USSR, Moscow began developing its pipeline strategy to avoid Ukraine, first with the Yamal-Europe pipeline, then Blue Stream, later with Nord Stream I, Turk Stream I and II pipelines, and finally the Nord Stream 2 pipeline, gas transit flows across Ukraine fell. Nevertheless, even as late as 2004, 137bcm was transited across Ukraine.
It can be argued that by keeping transit in place Ukraine reduces the risk to strikes on its natural gas pipeline network
Under what now appears to be the final transit contract agreed to run for five years from the end of 2019, the transit agreement for the final four years of the contract provided for just 40bcm annually to be shipped across Ukraine. Gazprom did though agree to pay on ‘ship or pay’ terms. So, even if it did not ship the gas, it was still required to pay the agreed tariff. However, with the onset of the full-scale invasion of Ukraine and the Russian occupation of the Sokhranivka entry point, gas was only transited by the Sudzha entry point (currently under Ukrainian occupation but with the gas still flowing). Hence, since May 2022, only 15bcm of Russian gas has flowed through Ukraine. This gas delivered under long-term supply contracts currently flows principally to Slovakia and the Russian-controlled statelet in Transnistria, with smaller amounts being provided to Hungary and Italy.
The Pros and Cons
There is clearly a case for continuing Russian gas transit. It would permit existing long-term supply contracts Gazprom has with Slovakia’s SPP and Moldovagaz for Transnistria’s gas supply to continue, as well as for the other minor customers of Gazprom via the Ukrainian transit route in Hungary and Italy. In the dead of winter when energy prices are high, it would mean European energy companies not having to find an additional 5% of supply on global markets. One can also argue that there is a Ukrainian case to sustain transit. This is not the often-made case that the transit fees are valuable to Ukraine. In fact, they do little more than cover the cost of sustaining transit. However, it can be argued that by keeping transit in place Ukraine reduces the risk to strikes on its natural gas pipeline network, which so far has only been subject to limited Russian attacks. Clearly, from a Russian perspective, the major argument in favour of sustaining the Ukrainian transit route is that this will permit Gazprom to obtain $6.5 billion in revenues. It will also help maintain commercial and political relationships with its customers and provide for the Russian-controlled statelet of Transnistria.
However, the arguments against are compelling. The first point is that as the European Commission has indicated there are plentiful alternative gas supplies available and all the customers of Gazprom have had sufficient time to make alternative arrangements.i Some customers of Gazprom such as SPP have recently taken steps to prepare for the time when the contract is set to expire, or have already terminated their long-standing relations with Gazprom, as in the case of Austria’s OMV in December 2024, with reference to “multiple fundamental breaches of contractual obligations by Gazprom Export.”ii Several other EU customers, such as Italian ENI and Hungarian MVM, have always had alternative sources of gas available and face limited risk. Only Moldovagaz seeking to provide Gazprom gas for Transnistria appears to be heavily exposed. Equally, while the Ukrainians recognise that there is a greater danger of Russian attacks on the gas pipeline network absent transit, they appear to be ready to take that risk. The network of pipelines is also extensive with multiple redundancies in the system limiting the overall impact of damage from Russian attacks. In addition, without the transit of Russian gas, far less of the network is required domestically. Furthermore, from the Ukrainian perspective, ending the transit regime would stop those $6.5 billion of revenues reaching Gazprom, whose losses in 2024 are expected to be significantly greater than the $7 billion in 2023.
The Barriers
There are also a number of other not insignificant barriers to delivering any fast deal. First, it is clear that the government in Kyiv, given the ongoing war with Russia, is understandably opposed to a direct contract with a Russian state-controlled company. This has been made clear by all levels of the Ukrainian government, from President Zelenskyy down. Currently, Gazprom ships the gas, pays the tariff, and covers all insurance costs. If Gazprom does not cover the tariff and insurance, someone else has to. One option is for the existing customers – individually or collectively – to book capacity on the Ukrainian network with the Gas Transmission System Operator of Ukraine (GTSOU), its transmission system operator, and buy gas at the Russian-Ukrainian border. However, that means that the customers take title and risk as soon as the gas enters Ukraine. How easy will it be for any of Gazprom’s customers to obtain what would amount to war risk insurance? Then, there is the issue of tariffs. It is likely that any new tariff will be adjusted significantly upward to reflect what would be a much smaller gas flow through Ukraine than that which was agreed under the 2019 Transit Agreement. How far does a higher tariff make the transit of Russian gas a real commercial prospect for Gazprom’s current customers served from the Ukrainian route?
The government in Kyiv, given the ongoing war with Russia, is understandably opposed to direct contract with a Russian state-controlled company
Even if capacity can be booked, and insurance and tariff issues concluded satisfactorily, there are a couple of further Ukrainian issues to be addressed. One is that even if there is no transit agreement between Gazprom and the GTSOU and customers book their own capacity on the Ukrainian network, the Russian and Ukrainian parties must be willing to adopt a new interconnection agreement. The current interconnection agreement also expires on 1 January 2025. Without it, no transit arrangements of any sort can be brought into operation. However, given the positions taken on ‘no contracts’ with Russian entities by Kyiv, this should mean no interconnection agreement can be agreed. There is also the issue of the missing $1.4 billion in transit tariff payments. As explained above, Gazprom is supposed to pay tariffs for 40bcm annually from 2020-24. Since 2022, it has only paid transit fees for 15bcm annually. This is due to the Russian occupation of the Sokhranivka entry point. The GTSOU offered another entry point still under the control of Ukraine. Gazprom refused and reduced transit payments. Ukrainian Naftogaz on behalf of the GTSOU has launched arbitration proceedings to seek recovery of the lost $1.4 billion. It is unlikely – unless it was paid – that Ukraine would accede to any new transit deal in whatever form it took.
The Unlikely Alternatives
One alternative brought up in recent months is the prospect of Azerbaijan stepping in and providing gas to Gazprom’s customers. Although much discussed, it is likely to prove unworkable. In essence, the fact is that Azeri SOCAR, a state-owned energy company, does not have a spare 15bcm of natural gas to ship to Russia and then through Ukraine. Hence, any deal involving SOCAR will need a mechanism where Gazprom gas is acquired by SOCAR, then shipped through the Ukrainian network, and reconverted to Gazprom gas when it leaves Ukraine. While this is possible, it is also so obviously artificial that it is likely to raise significant political opposition internally in Ukraine. In addition, as with direct Russian participation in a transit agreement, there would still be a need for an interconnection agreement between Gazprom and GTSOU.
Also looming over Gazprom are the approximately 20 arbitration cases against it as a result of its non-fulfilment of its long-term supply contracts in 2022. Uniper was awarded €13 billion in June by the Stockholm Court of Arbitration, and OMV a further €230 million by the International Chamber of Commerce in November.iii Polish Orlen has indicated it has an outstanding claim of €4-5 billion against Gazprom. The difficulty here for Gazprom is that as these awards are handed down, it will face seizure litigation for the income receivables from its continuing clients. This has been taken so seriously by Prime Minister Orban that in May, following Orlen publishing details of its claim against Gazprom, a decree was issued providing a legal shield for Gazprom against seizures in Hungary.iv The difficulty for Gazprom and its potential customers is that the prospect of litigation seizures undermines the case for taking any Gazprom gas, at least until these cases are settled.
At a time when the Ukrainian government is desperately seeking to sustain American support for the war effort with the incoming Trump Administration, the prospect for a gas deal between Ukraine and Russia is politically toxic
The final and perhaps decisive issue for Kyiv, however, is this: at a time when the Ukrainian government is desperately seeking to sustain American support for the war effort with the incoming Trump Administration, the prospect for a gas deal between Ukraine and Russia is politically toxic. President Zelenskyy can hardly go to President Trump and seek military and financial aid, while at the same time being seen as facilitating if not a direct then some form of indirect gas deal with Russia. It does not matter that the commercial reality is that the transit fees only cover the costs of the operation of the transit regime. The perception would be that Kyiv was undertaking a gas deal with Moscow while seeking American support. In some respects, the proposed indirect arrangements with customers booking capacity or the proposed labelling of Russian gas as Azeri gas are worse because the perception would be that Kyiv was trying to hide a deal with Moscow from Washington.
The Consequences
The balance of argument is that absent a last-minute miraculous rabbit being pulled from the hat, it is difficult to see how a transit deal can land in time. There are several consequences which result from the failure to sustain gas flows across Ukraine.
The most immediate consequence is that the EU will need to find an additional 5% of supply for this winter. However, most Gazprom customers have already taken measures to ensure alternative supplies are available. In addition, as the Commission has indicated gas is available and the impact on pricing is likely to be minimal. The one territory where the ending of transit will have a potentially significant impact is Transnistria. Here, the loss of the 2bcm of annual gas flow, provided essentially free by Gazprom to sustain the statelet, can inflict economic losses and trigger destabilisation. In addition, Transnistria generates 80% of the power for constitutional Moldova. Gazprom did have the option on 16 December to take up auction capacity to bring gas via the Trans-Balkan pipeline to Transnistria. It did not take up any of the auctioned capacity.v If there is no transit deal on the Ukrainian side, it is therefore likely that the EU and other western allies may well have to provide support for Moldova and the statelet to minimise the impact of the termination of the transit regime.
There are also potentially three significant longer-term consequences. The first is the deepening integration of the Ukrainian gas system into the European market. The focus for the future is likely to be on deploying Ukraine’s immense storage capacity to underpin Europe’s supply security.
Second, with the closing of the door on Russian gas, and the prospect of much more LNG available from the US and Qatar, it is likely that LNG will take a much more prominent role in European gas markets. We have already seen Commission President Von Der Leyen raise the prospect of a great gas deal with the incoming Trump Administration.vi The economics of such a deal would work if it were underpinned by long-term supply contracts, making it easier for LNG firms to raise capital and pass on those lower costs to customers.
Third, Turkey will become the only entry point for Russian pipeline gas into the EU. Clearly, there is a danger whereby Gazprom seeks to not only use the 16bcm of the dedicated Turk Stream 2 pipeline but also the much larger capacity Trans- Balkan pipeline on reverse flow. One major area of concern that has been already identified surrounds the labelling of gas sourced from Turkey. Is the gas really Turkish, or is it in fact re-labelled gas from Gazprom? This issue is likely to become of ever greater concern as the EU moves to its April 2027 target for ending all Russian pipeline gas entering the union.
It may be possible for a deal to be delayed perhaps until the end of the winter heating season. By then, parties may have reconsidered their positions. Gazprom may be willing to settle arbitration awards reducing the litigation risk. The position of President Trump regarding Ukraine will be clearer, and there may be willingness to contemplate some minimum level of Russian gas flow on the EU and Ukrainian sides. However, the longer the delay in coming to any deal, the greater the likelihood that the transit of Russian gas across Ukraine has gone for good.
Endnotes
i. John Ainger, “EU Sees ‘Negligible’ Gas Impact From End of Ukraine Transit Deal,” Bloomberg, 11 December 2024.
ii. Farid Zohrabov, “Azerbaijan’s gas supplies to Slovakia to benefit both countries – expert,” Trend News Agency, 5 December 2024; “Austria’s OMV terminates Gazprom gas contract after supply row,” Reuters, 11 December 2024.
iii. “Uniper terminates Russian gas supply contracts,” Uniper, 12 June 2024.
iv. “Hungary Legislates to Protect Gas Payments to Gazprom – But Does It Breach International Law?,” Queritus, 10 October 2024.
v. “Moldova confirms Gazprom has not booked capacity for gas transit to Transnistria for Jan,” Interfax, 18 December 2024.
vi. Barbara Moens, Gabriel Gavin, and Clea Caulcutt, “EU’s opening bid to avoid Trump’s tariffs: We could buy more American gas,” Politico, 8 November 2024.