Right close to the New Year Eve, on 30 December 2019, NJSC “Naftogaz Ukrainy” (Ukraine) and PJSC “Gazprom” (Russia) have marked the year 2019 by signing the long-awaited new gas transit contract.
This contract is largely perceived as a child of numerous mutual compromises, and the primary goal of this article is to depict what has been gained by Ukraine and what has been given up under the then-existing negotiation power of the parties.
The signing of the new contract is truly a landmark news for Ukraine, as it was signed during the times when the old gas transit contract’s term was coming to its end and Ukraine was at risk that the entire transit of Russian gas will be terminated or at least put on hold for a certain time. Thus, Oxford Institute for Energy Studies wrote that Russia was close to be sufficient in gas transit capacities without the Ukrainian gas pipeline even though the North Stream 2 has not yet been completed. This deficit of capacities could still be substituted by gas storages in Europe and gas terminal in Yamal. Moreover, Ukraine already understood the gas to Romania, Bulgaria and the Balkans will be transported via so-called Turkish stream (and this turned out to be true as South-directed gas pipeline of Ukraine is under-pumped already in 2020) and the risks of North Stream 2 were evident to practically everyone, especially when it remained (and remains now) unclear whether any loopholes in the US sanctions law could be identified to complete the pipeline construction and circumvent the sanctions imposed.
Unfortunately, the gas transit contract as well as the settlement agreements are not available to the public, and hence our conclusions shall primarily be based on the data contained in the Minutes of the meeting of the representatives of European Union, Ukraine and Russian Federation as well as companies from these countries (LLC “Gas Transmission System Operator of Ukraine”, NJSC “Naftogaz Ukrainy” and PJSC “Gazprom”) dated 19-20 December 2019 signed in Berlin and Minsk (the “Protocol”), as well as information disclosed to the public by the officials of Naftogaz and Gazprom.
Gazprom’s commitments: gains for Ukraine
At the first sight the gains Ukraine received are quite numerous and impressive. In particular, they are:
1. Ukraine signed a new gas transit contract for the next five years with the minimum gas transit of 65 bln cubic meters in 2020 and 40 bln cubic meters in each of the following 4 years on a ‘pump-or-pay’ principle
The execution of the new gas transit agreement was crucial for Ukraine, as the termination of transit of Russian gas through Ukraine would make the magistral gas transportation pipelines under-pumped and largely undemanded. This would also further result in decrease of the proceeds Ukraine is used to receiving for gas transit.
To fulfill the Protocol, the representatives of Naftogaz, LLC “Gas Transmission System Operator of Ukraine” (“GTSOU”) and Gazprom have signed two agreements to continue Russian gas transit through the territory of Ukraine for the next five years until 2024 inclusive.
These agreements are:
1) interconnection agreement between GTSOU and Gazprom establishing technical procedures and rules for cooperation between the operators of the adjacent networks;
2) agreement on organization of transit between Naftogaz and Gazprom setting conditions and transit volumes for the next five years.
A real victory is the introduction of the European “pump-or-pay” principle to the new contract (unlike the “take-or-pay” principle incorporated in the 2009 gas supply contract) under which Gazprom guarantees minimal transit volumes of gas in the amount of 65 bcm per year for year 2020 and 40 bcm per year for 2021-2024. However, this obligation will be effective only provided that by the date of gas booking NEURC will adopt a competitive tariff which will be acknowledged by Gazprom and correspond to the level of gas transportation tariffs used in Western and Central European countries.
Moreover, NEURC shall adjust the terms of the model gas transit agreement with the terms of the contract signed between Gazprom and Naftogaz, and the parties shall later sign the new model gas transit contract under the Ukrainian law.
Interestingly, the tariff for organization of gas transit will remain confidential, though the mere tariffs for transit are set by NEURC and are publicly available. According to the Executive Director of Naftogaz, Naftogaz’s minimal proceeds generated from this contract (if contracted amounts will not be exceeded) will constitute circa USD 7.2 bln (i.e. USD 32 per one thousand cm of gas transit).
2) withdrawal of Gazprom’s investment claim for USD 7,4 bln re AMCU case (the settlement agreement has been approved by the Cabinet of Ministers of Ukraine on 27 December 2019 and empowered Minister of Justice to execute it, which he consequently did)
Thus, in January 2016 the Antimonopoly Committee of Ukraine ("AMCU"), following an investigation on the alleged violation of the Ukrainian antitrust legislation, issued a decision finding that Gazprom abused its dominant position on Ukrainian market as a sole buyer of gas transit services through Ukrainian gas transit pipelines ("AMCU Decision") [1]and imposed a fine on Gazprom in the amount of USD 3,5 billion. Due to non-payment of fine by Gazprom, its amount further increased two times following the accrual of penalty, with the total amount subject to recovery from Gazprom of circa USD 7 billion [2].
Gazprom attempted to challenge the AMCU Decision in Ukrainian domestic courts, albeit unsuccessfully. In April 2017 Ukrainian state bodies started enforcement against Gazprom's assets in Ukraine and abroad [3].
On 25 October 2018 Gazprom filed circa USD 7,4 billion [4] investment treaty claim against Ukraine in accordance with UNCITRAL Arbitration Rules under Ukraine – Russian Federation BIT. This case ПТС № 2019-10 was being considered in Geneva, Switzerland.
3) commitment of Gazprom to pay outstanding USD 2.9 bln according to Stockholm case by 29 December 2019 (already received by Naftogaz on 27 December 2019) and withdrawal of appeals on the SCC Decisions which consideration has not yet been finalized.
Naftogaz and Gazprom have been involved into numerous arbitrations regarding 2009 gas supply and transit contracts for almost 6 years now.
Ukraine won USD 5 bln in the arbitration at Stockholm Chamber of Commerce which the decisions being issued on 28 December 2017 (on gas supply) and 28 February 2018 (on gas transit) (“SCC Decisions”). Part of the award in the above cases amounting to USD 2.1 bln was paid in gas as a set off and USD 2.9 bln remained due, since Gazprom did not voluntarily perform the arbitration decision.
Moreover, Naftogaz filed a new claim against Gazprom worth USD 12 bln for reconsideration of the gas transit tariff in 2018-2019 (“Stockholm case”), which has not yet been considered and decided by the arbitrators at IASCC.
Ukraine’s commitments:
At the same time, the part of the compromise was that Ukraine gives up on:
1) its pending claims at the Stockholm Case for the amount of USD 12,2 bln and 1,33 billion cubic meters of gas (with no pecuniary evaluation). On 31 December 2019 Naftogaz and Gazprom signed settlement agreement according to which both parties abandon mutual claims under the 2009 contracts;
2) all the arrests imposed on property, assets and monies of Gazprom as well as refusal from all possible claims under the gas supply and transit contract dated 19 January 2009 in future
3) its further enforcement proceedings under AMCU case with the total amount subject to recovery from Gazprom of circa USD 7,4 billion.
The good news is that the issue of gas supply was not subject to agreements, and the parties declaratorily noted they may resume the negotiations on gas supply to Ukraine in future with the pricing based on the European hub price (NCG). Moreover, the deal does not impact Naftogaz’s claims against Russia regarding the assets seized in the Crimean Peninsula.
The deal also envisaged that by 29 December 2019 Ukraine will undertake all the necessary steps:
1) for a final decision on certification of LLC “Operator of gas transport system of Ukraine” and its licensing, while the European Commission shall guarantee and confirm in writing the certification of LLC “Operator of gas transport system of Ukraine” and that Ukrainian gas transportation legislation complies with the EU requirements;
2) for guaranteeing of legal validity of National Energy and Communal Utilities Regulation Commission (NEURC) on terms of capacities booking in 2019 and possibility - to conclude the new gas transportation agreement in the version agreed upon by the parties
3) for ensuring of independence of NEURC, stability transparency and economic viability of gas transportation tariffs.
Instead of an Afterword
Sceptics may claim that Ukraine’s withdrawal from the claims worth more than USD 19 bln for the sake of USD 7 bln to be received under the transit contract over the next 5 years do not make a good deal, to say the least. However, it should be noted that these USD 12 bln under the Stockholm case and USD 7 bln under the AMCU case are not the monies already in the suitcase waiting for Ukraine to pick them up, but merely an estimation of claims.
In this respect it is wise to keep it mind that:
1) further arbitration processes and enforcement proceedings would require large costs from Ukraine to pay for its lawyers and experts
2) usually arbitrators tend to find a certain compromise and to award a smaller sum than asked for, and
3) most importantly the enforcement proceedings against Gazprom in multiple jurisdictions would not necessarily end up with a success in any nearest future, if at all.
Furthermore, some critics point out that certain terms and conditions of the new transit contract are worse that those of 2009 contracts. While this may be objectively true, one cannot forget that the new agreement was concluded in the new circumstances, i.e. in 2009 there were no operating Turkish and North Stream-1 gas pipelines and North Stream 2 has not yet even been conceived. Moreover, the previous contract had a “take-or-pay” principle which obliged Ukraine to buy 40 bln cm of gas per annum for an above-market price, while Gazprom was obliged to pump 110 bln cm of gas without a “pump-or-pay principle” and could stop the transit upon the prior written notice. In the new contract the absence of a take-or-pay and presence of pump-or-pay principle proves to be advantageous for Ukraine.
[1] Decision of the Antimonopoly Committee of Ukraine No. 18-p of 22 January 2016
[2] Ukraine: Gazprom Fine of US$6.7b Reinforced
[3] Judgment of Kyiv Commercial Court of 18 June 2017
[4] The amount of claim is approximate, as the particular amount of Gazprom's claim is not publicly available and different sources cite different amounts, allegedly based on the different foreign exchange rate of Ukrainian Hryvnia to US dollar at the particular dates; Investment claim against Ukraine Follows an Antimonopoly Fine Imposed on Gazprom.
Author: Iaroslav Cheker, Counsel, Head of Energy and Natural Resources at Arzinger Law Firm