Ukrainian political battle could hit European gas prices

Ukrainian political battle could hit European gas prices
Alex Dryden, The Daily Telegraph, 29 Jul 2008

'Wear two jumpers' was the advice recently given to British homeowners facing higher gas bills by Jake Ulrich, managing director of Centrica Energy, part of the group that owns British Gas.

More recently, Ian Marchant, chief executive of Scottish & Southern Energy, warned that there would be further price hikes in our gas and electricity bills even before winter. Then, on Friday, EDF announced that it would be increasing gas prices to its UK customers by 22pc, blaming wholesale energy costs for the latest price hike.

Ukrainian political battle could hit European gas prices
Alex Dryden, The Daily Telegraph, 29 Jul 2008

'Wear two jumpers' was the advice recently given to British homeowners facing higher gas bills by Jake Ulrich, managing director of Centrica Energy, part of the group that owns British Gas.

More recently, Ian Marchant, chief executive of Scottish & Southern Energy, warned that there would be further price hikes in our gas and electricity bills even before winter. Then, on Friday, EDF announced that it would be increasing gas prices to its UK customers by 22pc, blaming wholesale energy costs for the latest price hike.

Although the price of oil has fallen back from its $147-a-barrel high, Britain's leading energy companies still expect consumers to face bigger energy bills this year. MPs are unhappy. Yesterday they claimed that the market is not functioning properly and urged the Government to introduce a windfall tax on utility companies to help families.

However, a battle for political supremacy in far-off Ukraine is likely to have just as big an influence on European gas prices in coming months as the fluctuations on global energy markets.

Britain now imports 21bn cubic metres of gas every year since its North Sea reserves started falling. Some imports come by ship as liquified natural gas and some has to be bought in the European markets which is then piped over to the UK mainland from the Continent.

But much of Europe's gas is imported from Russia through pipelines that cross Ukraine. It is the control of those pipelines that is now the subject of a tense political tussle between Ukraine's President Victor Yushchenko and his former ally turned rival, Prime Minister Yulia Tymoshenko.

At the heart of the politicians' struggle is an oligarch whose influence will play a major part in dictating the price of gas in Britain's wholesale markets.

President Yushchenko believes the existing arrangements should remain and that current prices for gas transit payments should not be reviewed. He believes that the existing deal, whereby 55bn cubic metres of gas are delivered to Ukraine at $179.50 per cubic metre, is the best possible one. But he faces formidable opposition.

Behind Tymoshenko's plan, known in Ukraine as the "change of concept", is Gayduk. Like Tymoshenko, Gayduk was formerly an ally of President Yushchenko but has fallen out with him over the gas transit question.

Tymoshenko made Gayduk her chief adviser earlier this year. He is the head of a business conglomerate called the Donbass Industrial Union (DIU) but little else is known about "the quiet Donetskian", as he is called, except that he is one of Ukraine's most powerful oligarchs.

He made his fortune, estimated to be in the region of $5bn, between 1998 and 2001 supplying gas to the Donbass region, where half of Ukraine's industry is located.

A Tymoshenko representative, however, states that her critics are wrong to focus on Gayduk. "Tymoshenko's long-term strategy is all about transparency," he said. "We've always said there should be no middleman. It is better if Ukraine's state agency NaftagasUkraini can buy direct from Russia. I've never heard of any suggestion that Vitaly Gayduk would be involved."

The political conflict between Tymoshenko and Yuschenko is expected to come to a head at the next presidential elections, likely to be held in November. According to a broad range of western and Ukrainian political analysts, if Tymoshenko replaces Yuschenko as president, or manages to usurp presidential power to her prime minister's office, she will implement her plans to change the gas transit arrangements.

"The result of there being no middleman will be that direct gas supplies from Russia will actually increase the price of gas, not decrease it," says Weiss. "Russia will have a greater influence on the price of gas. Ukrainian industrialists will then lobby for a new middleman. The new middleman will be Gayduk and DIU."

Tymoshenko has claimed that changing how gas is transported across Ukraine is a fight against "Gazprom's and the Kremlin's price dictatorship", but her apparent opposition to the Kremlin is at odds with her ally Gayduk's connections in Russia. He is close to the Russian gas exporter Gazmetall which in turn has close connections to the Kremlin.

Gayduk's DIU business has been attempting to negotiate a merger with Gazmetall whose leaders - principally Alisher Usmanov - are very close to the Kremlin's ruling elite under Dmitry Medvedev and, formerly, Vladimir Putin. Under the presidency of Medvedev in Moscow, the activities of Gazmetall in Ukraine have been growing significantly.

Another partner of DIU is Andrei Kostin, head of Russia's state bank, Vneshtorgbank, and a close friend of Putin. Gayduk also has close connections with Chelsea Football Club owner Roman Abramovich and Alexander Abramov, who together own the Russian steelmaker Evraz.

This Russian and Ukranian political intrigue over who controls the gas being piped to us in the West comes at a time when Western Europe's home-grown production of gas is in steep decline.

According to statistics from Eurogas, production fell by 4.9pc in 2006 and by 7pc in 2007, and this fall in production is set to continue ever more sharply. Norway is the main indigenous provider of gas in Western Europe, supplying 18pc of the EU's needs.

The UK's 21bn cubic metres of imported gas each year is steadily rising, while at the same time Western Europe's indigenous gas production declines. Already 10 EU countries are almost entirely dependent for their natural gas supplies on Russian and CIS gas production, with Ukraine as the transit country.

Ukraine is the vital link for Western Europe, and the prices we pay for the transit of gas - as well as the price for the gas itself - will be reflected in our industrial and domestic bills.

We can try wearing an extra jumper this winter, but the price of gas looks as if it is rising inexorably and the obscure political and business machinations in Ukraine will play an important part.

Vitaly Gayduk has made a huge personal fortune in gas trading and ownership of Ukrainian energy companies. But he is not simply a businessman, he is playing a pivotal role in a looming political crisis that threatens to send gas prices higher.

His influence on the Russian and Ukrainian gas markets that are so key to the UK came to the fore in the recent "gas wars" between Russia and Ukraine in which Russia sought to use its energy leverage for political gain, a tactic it has used several times with EU countries such as Lithuania. It was Gayduk who negotiated a solution to the row.

President Yushchenko and Prime Minister Tymoshenko, former allies since the Orange Revolution in 2004, are locked in a mounting conflict over the price of the gas that is piped across the Ukraine. The country's role as the transit country for 73pc of Western Europe's gas being exported by Russia and the CIS countries makes it vital to the EU's energy markets. What happens in the Ukraine affects what happens further west.

At the heart of the conflict is Tymoshenko's desire to abolish an intermediary arrangement that currently involves gas coming from Russia passing through a Ukrainian company called RosUkrEnergo. Instead she plans to buy gas directly from Russia and the CIS countries, through NaftagasUkrainy, controlled by her government. This is a move that most independent analysts agree will raise the price of gas for consumers in Western Europe.

"Such a course, abolishing a middleman, will increase the price of natural gas and will cause instability in the Ukraine", according to Lidia Lowson at the American Centre for Political Monitoring. "From this instability Tymoshenko will be able to impose her own middleman to calm the situation. That man will be Gayduk."

When contacted, Gayduk's office said he was unavailable for comment.

The reason that the price of gas will rise if bought directly rather than through an intermediary is that its price will be fixed by governments - principally Ukraine's and Russia's - rather than by organisations that operate through commercial criteria.

"Without an intermediary, the governments of Tymoshenko and [Dmitry] Medvedev will be able to dictate prices," Inna Weiss of the Central Group of European Political Monitoring says. "With the existing situation there is a clear interest in co-operation and good relationships with Western Europe. That is what Yushchenko represents."

Last week Alexei Miller, chairman of Gazprom, met with Tymoshenko to discuss the gradual rise in the price of gas from $179.50 to more than $400 per cubic metre.