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At the beginning of this year, it became known that Ukraine would not renew its contract with Russia for the transit of Russian gas to Europe. This contract, which expires on 31 December 2024, covers the transportation of 225 billion cubic metres of fuel over five years. Most of the Russian gas flowing to Europe was channelled through this pipeline. However, Kyiv has now made it clear that it has no intention of providing Moscow with transit capacity. While Europe was quick to express verbal support for this decision, Russia still anticipates the possibility of an extension to the agreement.
Which of the parties will suffer the most from the cessation of the pipeline that still carries Russian gas to Europe? Russia, which is steadily losing its European customers? Europe, which has yet to fully meet its gas needs through alternative suppliers? Or Ukraine, which remains heavily dependent on the transit of Russian fuel? Experts believe that such a decision will inflict serious damage on all parties involved.
IS INFLATION INEVITABLE?
The EU swiftly declared its support for Kyiv’s decision. European Commissioner for Energy Kadri Simson confirmed that the EU intends to cease using Ukraine as a transit route for Russian gas from 2025. She noted that Russia’s share of gas imports to European countries has already dropped significantly over the past year and a half. As for Austria, Slovakia, and Hungary, which continue to receive large volumes of Russian gas through the Ukrainian pipeline, the commissioner suggested that these countries could obtain fuel from alternative sources.
However, it is evident that these alternative sources are unlikely to even come close to covering Austria’s needs, where Russian gas imports still accounted for over 50% in 2023. Before February 2022, this figure was almost 80%. Therefore, experts agree that Austria, along with Slovakia and Hungary, will be more severely affected by the cessation of Russian supplies than other European countries. In these countries, the gas market may initially react with a sharp rise in energy prices, followed by a significant increase in the price of all other goods.
Slovak Prime Minister Robert Fico has already visited Kyiv to discuss the future of Ukrainian transit with his counterpart Denys Shmyhal. Following the meeting, Fico suggested that Russian gas might continue flowing to Slovakia via Ukraine in 2025. According to Fico, this decision would also “benefit” Austria and Italy, which receive Russian gas through the Ukrainian pipeline. However, Kyiv promptly denied his remarks, insisting that the gas pipeline shutdown is inevitable.
Meanwhile, Russian energy minister Alexander Novak stated that Russia is open to discussing various options for exporting its gas to Europe. However, there has been no interest from Brussels in such negotiations thus far. It appears the EU leadership believes that Austria, Slovakia, and Hungary should resolve these challenges independently.
Vienna is now grappling with the question of what to do if gas transit through Ukraine is indeed halted. Christoph Neumayer, head of the Federation of Austrian Industries, emphasises that Austria’s economy remains highly dependent on Russian gas. This dependence can only be reduced once the extension of the WAG pipeline, which connects Austria to Germany’s gas transport system, is completed. “What we need now is a political decision [on continuing to buy gas from Russia],” he said. Neumayer warned that if Russian gas stops flowing, prices in Austria could rise by 70% or more, as the market has yet to account for potential short-term fluctuations. Inflation in Austria could rise by 2.5 percentage points, and GDP could shrink by 2%. “We urgently need a consortium that can ensure the transit of Russian gas through Ukraine,” he urged.
Andreas Schröder, head of energy analysis at energy market research firm Independent Commodity Intelligence Services (ICIS), concurs. He says that if the flow of gas through Ukraine stops, this will cause serious problems for several countries – especially Italy, Austria, Hungary, and Slovakia. It would also inevitably drive up gas prices across the European market. The expert predicted that the gap between lower gas prices in northern European countries and higher prices in central Europe would widen even further.
The EU risks losing around 5% of its total gas imports as a result of the Ukrainian transit shutdown. This gas mainly goes to central and south-eastern Europe. These countries could receive gas through pipelines from Germany or Turkey, said Aura Sabadus, a senior analyst at London-based energy market data provider ICIS. However, Germany’s recent decision to impose a unilateral tax on gas exports makes this prospect far more complicated. According to Sabadus, the tax would reduce central European countries’ ability to invest in non-Russian gas supplies.
An internal European Commission analysis obtained by Politico warned that losing Russian gas supplies through Ukraine would lead to higher transport costs for EU countries and, inevitably, a hike in gas prices for both industry and households. Countries left without Russian supplies would need to find alternative routes, which could make diversification more complex and expensive. The document mentions that representatives of the European Commission are in ‘close dialogue’ with the affected countries on this issue.
SEARCH FOR ALTERNATIVE SOURCES
What alternatives could Europe turn to if Russian gas supplies through Ukraine are halted?
The European Commission has already conducted a preliminary analysis of various scenarios should transit through Ukraine be interrupted. However, none of these scenarios appears satisfactory. The option of purchasing gas from Azerbaijan is a case in point: while there is an agreement between Baku and Brussels to increase Azerbaijani gas supplies to Europe to a minimum of 20 billion cubic metres by 2027, last year Baku exported less than 12 billion cubic metres. Experts doubt Azerbaijan’s ability to increase supplies further. A report by the Oxford Institute for Energy Studies indicates that Azerbaijan has very limited opportunities to boost gas production. Additionally, importing gas from Azerbaijan is likely to be uneconomical for the Europeans due to the high delivery costs. In Italy, for example, Azerbaijani gas has already cost consumers nearly double the price of Russian gas. The high price of gas delivery from Azerbaijan is also influenced by technical difficulties related to the exploration and development of fields in the Caspian Sea. Finally, the capacity of the Trans Adriatic Pipeline, which carries Azeri fuel to Europe, is already fully utilised and has no room for growth.
Despite these issues, Kyiv favours the idea of pumping Azerbaijani gas through Ukraine rather than Russian gas. Ukrainian President Volodymyr Zelensky said that a successful outcome to negotiations between the EU and Azerbaijan would allow Ukraine to retain its role as a transit country. The agreement to replace Russian gas with Azerbaijani supplies is ‘one of the proposals’ being discussed, Zelensky said, for now ‘at the level of officials.’
However, the European Commission does not rule out a new contract with Gazprom Export as a last resort. One option is to conclude a new contract between Gazprom Export and a European energy company that would purchase gas at the Russian-Ukrainian border. The gas would then be sent to the EU, with Ukraine’s gas transport system operator receiving payment for transit. However, Ukraine is strongly opposed to this option. “We do not want to continue the gas contract with the Russian Federation,” Zelensky emphasised. “We do not want them making money here.”
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Since the outbreak of hostilities in Ukraine in February 2022, European states have also pinned high hopes on gas fields in Africa. Algeria has long supplied Spain with fuel via undersea pipelines. Now work has begun to expand their capacity to France and Germany.
Italy, in turn, buys gas from Libya. However, in order to effectively solve the ‘Ukrainian transit problem’, Europe must help both Algiers and Tripoli to explore new fields and increase gas production. Current supplies are clearly insufficient for Italy and Spain, let alone other EU countries.
That said, there are much larger gas fields in Africa, but they are all sub-Saharan, in Nigeria, Tanzania and Senegal. Theoretically, this gas could be supplied through the Trans-Sahara pipeline, which is only now being planned. But these prospects are already looking dim, if not unrealistic. The pipeline, which is more than four thousand kilometres long, would have to pass through a huge, ungoverned and conflict-stricken region. In any case, its capacity would not exceed 30 billion cubic metres of gas per year, which corresponds, for example, to about two-thirds of German imports from Russia in 2021. At the same time, the construction of this pipeline will take at least 10 years.
With its LNG imports to the EU, the US seems at first glance to be a real lifesaver in the current situation. The Americans already became the largest supplier of
this type of fuel to Europe in 2023, providing almost 50 per cent of total EU liquefied gas imports. However, this cooperation also entails considerable risks and gives no assurance of the stability of supplies – or of their being financially beneficial to European countries. European countries are forced to buy LNG from the US under spot contracts, where, as is well known, the prices for raw materials are much higher than under long-term agreements and the gas itself can go at any moment to a buyer who makes a more favourable offer. French finance minister Bruno Le Maire has already openly accused Washington of trying to make money from its partners and said that the Americans sell their LNG to European companies at four times the price at which they sell gas at home. The moratorium imposed in January this year by US President Joe Biden on issuing licences required for the development of new LNG fields does not add stability to US-European gas cooperation.
THERE WILL BE NO WINNERS
Russia is already suffering significant losses due to the EU’s decision to stop purchasing gas and is therefore keen to ensure transit through Ukraine continues. “Gazprom is currently in a difficult financial position. Production is at an all-time low, and they need to sell gas,” said Aura Sabadus of ICIS. Gazprom’s recently published accounts revealed that for the first time since its creation in 1994, the company ended the year with a net loss under International Financial Reporting Standards (IFRS), with the figure totalling 629 billion roubles—a record in the company’s history. If the Ukrainian pipeline is entirely closed to Russian gas in 2025, Gazprom’s exports to the EU will fall tenfold from pre-war levels, with losses growing exponentially.
Kyiv, too, risks significant losses if it disregards the consequences of halting the transit of Russian gas through its territory. Gazprom is required to pay around $1.25 billion per year for transit under the current agreement. Ukraine’s war-battered budget, which is in desperate need of additional revenue, could lose this income by following the principle of “cutting off your nose to spite your face”.
Sergey Vakulenko, an expert at the Carnegie Endowment think tank, stresses that Ukraine needs to maintain transit after 2024 for other reasons as well. Its gas transport and distribution system was built in the Soviet years with a large through-flow of fuel in mind. In the post-Soviet years, this flow continued to physically supply Ukraine with gas, even when Ukraine stopped buying gas from Gazprom and switched to buying from European traders.
Mechanisms of virtual reverse and virtual transport within Ukraine’s gas transport system have always been an important element of the work of the country’s gas industry. ‘Thus, without Russian gas transit, the costs of maintaining Ukraine’s gas transport system will fall entirely on the shoulders of domestic consumers with a corresponding rise in prices. In addition, Russian transit leaves Ukraine with the possibility of a virtual gas reverse, which reduces the overall costs of imports and simplifies their logistics,’ Vakulenko said.
What will remain if Ukraine refuses to renew its contract with Russia on gas transit to Europe? A scenario in which no one wins and all parties are left worse off seems inevitable.
Experts at the Center on Global Energy Policy at Columbia SIPA predict that the consequences of such a move will be severe. ‘Sudden halt to the remaining gas flows through Ukraine to Europe would be disruptive and raise gas prices not only in the affected countries, but also beyond,’ their analytical report states.
In order to avoid such a scenario, it seems that all parties will have to find a compromise. Experts do not rule out that following June’s elections to the European Parliament, the new European Commission may return to the issue of Ukrainian gas transit. Some variants of this compromise may already be starting to emerge. It has become known that Kiev may come to an agreement with one of the EU member states on the use of its gas transport network. Technically, there is such a possibility, Bloomberg notes: according to the agency’s source, Russia can deliver gas to the Ukrainian border, and a European company could then take it away for transport to any European country under a contract with the Ukrainian GTS.
Whether this option will work or another mutually acceptable solution will be found remains to be seen. One thing is clear: the path of confrontation in this case is not favourable to anyone.