Gazprom is blocking reverse gas flow from Slovakia to Ukraine in violation of EU law, says Andriy Kobolev, the CEO of Ukraine’s state-owned gas monopoly Naftogaz, in an exclusive interview with Slovakian energy analyst Jozef Badida. As a result European companies are not able to meet the demand from gas in Ukraine and Ukraine is left at the mercy of Gazprom. Kobolev calls on the EU to take action against the Russian company. But he also notes that despite Gazprom’s opposition, supplies to Ukraine from the EU have increased considerably since 2009. “The old days for Gazprom are over.” He calls on other Central and Eastern European countries to create an efficient gas market together.

As the gas dispute between Ukraine and Russia is flaring up again, Ukrainian national gas company Naftogaz is looking with increased urgency for supplies from the EU. The problem is that Ukraine does not have many possibilities to import gas from EU territory. There are two interconnectors to Hungary and Poland but they have only limited capacity. The best option is the Slovak-Ukrainian interconnector at Veľké Kapušany, which has an annual capacity of 80 bcm (billion cubic metres). Total Ukrainian consumption is around 50 bcm. This interconnector has been used mainly for westward transport. The possibility to use it in reverse flow would solve many Ukrainian problems.

That, however, is not so easy as Gazprom in this case not just ships gas, but also carries out functions that would typically be assigned to a transmission system operator (TSO).  It is not Ukrainian TSO Ukrtransgaz (UKtG) which notifies the shipper´s nominations for gas transportation to the Slovakian TSO Eustream, but Gazprom. Earlier negotations have led to a compromise decision under which Eustream has renovated a smaller, unused pipeline – between Vojany and Uzhgorod – for reverse flow, but this has a transit capacity of just 15 bcm. Kobolev says the European Commission should force Eustream and Gazprom to open up the large interconnector to reverse flow.

Eustream seems to be unwilling to challenge Gazprom on this. Miroslav Bodnár, Member of the Board of Directors and Director for Strategy at Eustream, says in response to our questions that this step should be preceded by tri-lateral negotiations between Gazprom, Eustream and Ukrtransgaz.

In a written statement, Bodnár notes: “The question of so called „big reverse“ was widely discussed between the highest representatives of Slovakia, Ukraine and the European Commission during meeting in Veľké Kapušany on 15.04.2014. All parties have at that time opted for a feasible solution of the new interconnection of the Vojany-Uzghorod pipeline, which has been successfully implemented with maximum effort and capacity, and acknowledged that implementation of the Big Reverse will be preceded by tri-lateral negotiations with Gazprom who is currently contractually carrying out part of the activities on behalf of Ukrtransgaz. Eustream remains ready to accept invitation for such negotiations and continue in light of 2014 agreements.”

Klaus-Dieter Borchardt, Director Internal Energy Market at the Directorate-General Energy, who represented the European Commission in the negotiations with Naftogaz and Eustream, agrees with Kobolev that “There should be an Interconnection Agreement between UKtG and Eustream and in the follow-up a revision of the Transit contract and the contracts between Eustream and Gazprom. The Commission is facilitating the talks between UKtG and Gazprom and we are also in contact with Eustream.”

But he acknowledges that “For the moment the chances for those talks are not big because Gazprom refuses to touch upon the Transit Contract.” He adds that, “in my view the situation might only change once we have the decision from the Arbitration tribunal in Stockholm”, referring to the mutual claims Naftogaz and Gazprom have filed against each other in Stockholm.

Jozef Badida caught up with Kobolev recently at the Central European Energy Conference 2014 in Bratislava where the CEO of Naftogaz held a presentation and spoke with him about the situation around the interconnection with Slovakia and the developments in the Ukrainian gas market in general.

In your presentation you emphasised the importance of the possibility of a large reverse flow to Ukraine. What is behind this idea?

Firstly, it is not correct to call it a reverse flow. The correct name of this idea is backhaul as it is called in the gas industry. It requires a signed interconnection agreement between Eustream and Ukrtransgaz. That doesn’t mean that the Gazprom contract which they signed to book capacity will suffer or Gazprom will not be able to transport gas. But it will allow Ukraine and Slovakia to optimise gas flow without being blocked by Gazprom. Take the example of a European company willing to send its gas from Slovakia to Ukraine in a volume, let´s say, of 50 mcm (million cubic metres) per day. At the same time, there is Gazprom sending 100 mcm of gas through Ukraine to Europe. In a normal situation, and that is what Eustream is doing at its Western borders, you will do just simple netting, sending just the resulting balance across the border. And everyone is happy.

We speak about virtual reverse flow.

Yes, indeed. Gazprom receives its full volume of gas in Slovakia for further transportation to its EU clients while the European company is able to deliver gas to Ukraine. Nobody is affected in a negative way. What will be modified is that Gazprom will not be able to block such flows. At the moment they are trying to block the flow from Europe to Ukraine which is against any market principle and legislation, such as the 3rd Energy Package and anti-monopoly law of the EU.

So the main problem is that there is no interconnection agreement between Eustream and Ukrtransgaz and thatGazprom plays the role of intermediary, right?

Well, the role of Gazprom is very specific. It plays the role of matching partner, which is definitely against the EU law. Gazprom as a shipper, under the European legislation, cannot be a matching partner. That is prohibited. So what we are trying to achieve is to make sure that Eustream and Ukrtransgaz are matching partners. In that case, a virtual flow will be available for both sides, not only for the Ukrainian side but also for Eustream. This will allow a free flow of gas in both directions.

How is it possible that Gazprom is in this position, as you said, not complying with EU law?

We believe there are still old arrangements between Eustream and Gazprom which need to be brought in line with the current directives and regulations. From our side, we, as Ukraine, are prepared to change our contract with Gazprom in that respect as needed.

So you have a transit contract which gives Gazprom the privilege to be a matching partner, right?

No, we didn’t give this right to Gazprom. For us, changing this contract is much easier. Actually, our analysis shows that it is quite an easy task. The key issue is the preparedness of Eustream to change its contract with Gazprom. And yes, Gazprom will not like it.

So how can it be done? As you mentioned, Gazprom would be quite reluctant.

Indeed, but there is the principle of rule of law. If there is legislation which clearly says that interconnection agreements should be signed by gas transmission system operators only, then this is something that needs to be done. There are many cases in Western Europe when interconnectors were blocked by shippers who used their dominant position, and the European Commission required those agreements to be changed. And the contracts were changed. If it is against the law then it must not be in place.

Slovakia has been an EU Member State for 10 years and the Slovakian contract with Gazprom still operates. Doesn’t that mean it is not in breach of EU law?

No, it is against EU law. We are in permanent discussion about this with the European Commission. If you look at the implementation of the 3rd Energy Package, it is gradually moving from the Western to Eastern European countries. So slowly, bit by bit, these changes are being implemented at different interconnectors. It is a matter of time. So people understand it is against EU law but there should be some efforts on the Slovak side and the side of European Commission to implement the changes.

How do you want to motivate Slovakia to take action?

We believe the principle of European solidarity should be applied. There is EU legislation and Ukraine has joined the Energy Community, taking on the obligation to implement the 3rd Energy Package, so I don’t see why it should not be done. Unlocking the primary interconnector is beneficial not only for Ukraine but for other countries, such as Hungary, Romania and Bulgaria, as well. They can source gas through Ukraine and get access to Western European gas and our underground gas storages.

The OPAL pipeline, connecting Gazprom’s Nord Stream with the Central European grid, has been granted a 50% exemption on third party access.

Yes, this is a good example. We believe exemptions should not be granted. Now large international companies which want to supply gas to Ukraine via Nord Stream and Opal are being cut off by Gazprom. We know there are several cases of Gazprom reducing supply to those countries even through Nord Stream.

But Ukraine currently imports around 1 bcm of gas per month from the EU. How is this possible if your suppliers are cut off by Gazprom?

That is because Gazprom is not the only supplier. It is a fact Gazprom doesn’t want to realize. Due to the 2009 gas crisis and Russia’s recent actions, European companies and customers have created other sources of supply to replace Gazprom. The best examples are the LNG terminals. Those companies are not dependent on Gazprom anymore to the extent they were two or five years ago. Moreover, they respect contracts, not political ideas, and they are supplying us.

Do you have many suppliers? Is there already competition of gas deliveries?

There are many gas suppliers and we are selecting the best in terms of conditions. Companies come to us, they make offers and we are able to choose those that offer the best price. One of the facts we wanted to prove, and we believe we have already proved it, is that there is enough free gas in Europe which can be supplied to anyone. That happened due to the implementation of the 3rd Energy Package mostly in the Northern European countries.

It seems that you are trying to change the historical system of gas deliveries to Ukraine.

No, we are not doing that. We are just trying to implement the measures which have already been implemented in Northern Europe. If you look at Germany or the Netherlands and the way markets are functioning there, they have created efficient markets. And they have done it in a simple way. They have removed the monopoly position of incumbent companies, not just Gazprom. By doing that they managed to achieve an efficient market. What we are suggesting to the Slovaks, Hungarians, Poles and Czechs is to create an efficient market here, in this region. And it is quite easy. You don’t have to adopt new legislation – just implement the existing one which has already proven to be efficient. As a result, you will unlock a huge market potential. That will be for the benefit of everyone, not only Ukraine. Speaking of Slovakia, the more gas is transported through your country, the more money Eustream will make.

They might lose Gazprom as a client.

No, why would they lose Gazprom?

At the moment Gazprom is rerouting its gas deliveries to Europe, mostly using Nord Stream. They don’t send their gas through the Slovak-Ukrainian gas corridor so much.

Yes, that is true. But firstly, there is the ship-or-pay condition in Gazprom’s contracts with European TSOs. Using other routes affects their costs. Secondly, if the Russians are confronted with a united, determined position of the European countries they will change their tactics. They will play by the rules. They will not be able to discriminate European consumers anymore. This is a bluff that needs to be called. The old days for Gazprom are over. Gas prices are declining. Oil prices are falling. New suppliers are reaching the European market. Gazprom needs to fight for its market share. If they stick to their current strategy, their market share in Europe will soon become very small. This is something they can´t tolerate for long. They  can pretend they don’t care, but in reality they can´t afford it.

Do you think that the backhaul to Ukraine is the main condition for creating this regional market?

We believe it is one of the key elements which are missing. Firstly, European companies will get access to the largest market in this part of the world. Secondly, they will get access to the largest underground gas storage. And thirdly, you will connect Balkan countries, Hungary, Romania, and Bulgaria with the western European markets in a very efficient manner. You see it is not just about Ukraine. We believe some work should be done in other countries, too. There should be the extension of pipeline capacity in Poland and Lithuania to cover their LNG capacities. Therefore countries like, for example, Slovakia or Ukraine, can get access to LNG.

But LNG is more expensive than piped gas.

Well, the price of LNG is fluctuating. Now, it is going down and at some point in time LNG will be competitive. For instance, the LNG price for Baltic States is not worse than the price recently offered by Gazprom to these countries. In the end, in order to get lower prices from any supplier, it doesn’t matter whether it is Gazprom or Eon, you have to show that you have alternatives. Until that time, any supplier will be able to charge you a higher price. If there is competition, the price will be lower. If you look at the global LNG picture, you will see that Japan will likely decrease its LNG consumption because they are re-launching their nuclear power plants. The US is trying to increase the export of LNG. So in two or three years I expect significantly lower LNG prices. But even now, the LNG price is competitive in some countries, for example in Spain. In conclusion, the more alternatives you have, the more efficient your market is. That is what we need to create here – an efficient market. Our idea is that the Eastern European countries should create a joint and efficient gas market. And the more liquid this market is, the fairer the price we all are going to get.

There is a huge potential but also uncertainty with regard to the situation in Ukraine. There are probably not many companies willing to invest in the Ukrainian gas sector. They are simply afraid.

Why would you need to invest? You just need to trade gas. There are many companies now willing to trade with Ukraine. If you look at the open season which was run by Eustream there had been many companies willing to supply gas to Ukrainian consumers and some of them have actually won a part of the capacity and are currently supplying.

Two final questions. Does Ukraine really need full underground gas storages in order to ensure a stable gas flow to Europe?

No. Our transit flow doesn’t depend on the UGS because we take gas from the East and then bring it to the West. Gas flows directly through Ukraine and there is no connection with the UGS. That is a misconception. However, Gazprom is not able to cover peak demands in Europe immediately because it takes 36 hours to transport gas from the Eastern to Western borders of Ukraine. So to cover this peak consumption they need to use our underground gas storages.

And is it true that some Russian gas suddenly disappeared from Ukrainian UGS at the end of 2013?

There was no Russian gas in Ukrainian UGS in 2013. Actually, the last Russian gas stored in our UGS was in 2005. There was a dispute between several companies about certain volumes of gas. And one of them was RosUkrEnergo, a Swiss company with a notorious reputation in Ukraine. But it has nothing to do with any disappearance of gas.

We realise that following a decade of constant bickering between Ukraine and Russia over gas there is an issue of trust in us and in our system. The Russians have made up too many fake stories that Ukraine did not refute in time. That is why raising transparency was among the first items on my agenda when I took over in Naftogaz last spring. In May, we have started publishing balances in our underground storages at the GIE transparency platform transparency.gie.eu. This autumn, we have started providing information on gas inflows and outflows in our system at the ENTSOG website transparency.entsog.eu. We have made numerous requests the EU to send its envoys to gas metering stations to monitor the inflows and outflows of gas in Ukraine. I hope this and our other actions will help to rebuild trust.

We want to start providing gas storage services to several European companies, and we are currently negotiating conditions for that. And I believe we will be successful.

Andriy Kobolev was appointed CEO of Naftogaz in March 2014, at the age of 35. Before that he was an advisor at the private investment and banking firm AYA Capital and management consultant at PriceWaterHouseCoopers. From 2002 to 2010 he worked Naftogaz in various capacities, including director of Corporate Finance and Pricing Policy.

This interview was conducted by Slovakian journalist Jozef Badida who runs the website EPV (Energie pre Vás). It was first published in Slovakian on EPV here.  All rights reserved.