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The election in Ukraine of pro-Russian President Viktor Yanukovich in February 2010 has led to a new wave of gas export negotiations between Russia and Ukraine. A new Russia-Ukraine energy deal agreed in April 2010 will give Ukraine reduced gas prices to help it cope with its economic crisis, but it will also tie the Ukrainian economy to a dependence on Russian subsidies.

  • In April 2010, Russia signed up to a new gas deal with Ukraine, establishing new preferential gas prices. In contrast to previous prices of US$300 per 1,000 cubic metres, Ukraine will now receive a discount of US$100 per 1,000 cubic metres when the price is higher than US$330 per 1,000 cubic metres and a 30% discount when the price is lower;
  • Russia’s economy is highly dependent on its energy exports, with exports of mineral fuels constituting 63.8% of total exports and 15.8% of the country’s GDP in 2009;

Russia’s gas exports, exports of mineral fuels and other exports: 2004-2009

US$ billion

Source: Euromonitor International from IMF, International Financial Statistics, United Nations, UN Trade StatisticsNote: Exports of gas data refers to both natural and manufactured gas.

Ukraine, on the other hand, relies on Russian gas for the operation of its highly energy inefficient economy, due to obsolete manufacturing and agricultural practices and infrastructure. Furthermore, Ukraine is also an important transit corridor for Russian gas to the European Union (EU). Disputes over gas prices between Ukraine and Russia have occasionally caused energy shortages for European consumers and businesses, most recently in 2009.

Implications

  • The more favourable gas prices will allow the Ukrainian government to save up to US$40 billion. This saving has helped to improve the country’s international credit rating and allowed the government to adopt a new 2010 budget without meeting the tough financial criteria set by the IMF. Ukraine’s economy fell into a recession in 2009, contracting by 15.4% year-on-year in real terms and having to resort to a US$16.5 billion loan from the IMF;
  • In the short and medium term, the new deal also has positive implications for the EU’s energy security, as over 20.0% of the EU’s gas needs are covered by Russian gas transited through Ukraine;
  • As for Russia, closer collaboration with Ukraine puts Russia in a better position to compete with the Nabucco gas pipeline, designed to reduce the EU’s dependence on Russian gas. The Nabucco pipeline which will deliver gas from the Caspian states to the EU through Turkey is expected to become operational by 2015;
  • Russia will also gain politically as the new deal leads to the Ukrainian economy’s dependence on Russian subsidies. As part of the new deal, Russia also gained a 25-year extension of its lease of Sevastopol naval base in the Black Sea;
  • Russia’s over-reliance on energy exports poses a range of problems to its economy, including an exposure to international price volatility, environmental degradation and the limited job creation potential of the energy sector. Russia’s unemployment reached 8.3% in 2009, from 6.3% in 2008;
  • Domestically, natural gas accounted for 53.5% of Russia’s primary energy consumption in 2009. Despite the advantages for businesses and consumers of natural gas, such as cost, energy efficiency and lesser environmental impact, the Russian government has been slow to realise its targets for further gasification. With the economic recession hitting public spending and a government budget deficit of 5.2-5.4% of GDP expected in 2010, levels of domestic natural gas use are likely to remain below potential in the short and medium term.

Russia primary energy consumption: 2009

%

Source: Euromonitor International from BP Amoco, BP Statistical Review of Energy.

Prospects

  • As international energy demand increases in 2010 in line with the global economic recovery, Russia expects to see a boost in gas export earnings, allowing the government to invest in further anti-crisis measures. In Q1 2010, Russia’s gas exports increased 120% year-on-year, to reach 52.1 billion cubic metres. In 2010, Russia’s GDP is forecast to grow by 4.0% year-on-year in real terms, compared to a contraction of 7.9% in 2009;
  • Russia will be looking to diversify its export destinations away from the EU and increasingly to Asia. The government has approved plans for construction of a new pipeline to China, set to begin in 2012;
  • Despite concerns over Russia’s increased political influence in Ukrainian domestic affairs, Ukrainian consumers and businesses are likely to see improved economic stability and lesser risk of energy shortages as a result of the new gas agreement between the two countries. The Ukrainian economy is forecast to see a modest recovery in 2010, growing by 3.7% annually in real terms.
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