Thinking through the importance of the Stockholm Arbitration ruling yesterday for Ukraine. Here are a few important points from my perspective:
Let’s be honest, this decision came as a totally unexpected, but positive, surprise for Ukraine. Few people were expecting a Ukrainian victory in the ‘take of pay claim”. We have to acknowledge that Gazprom likely will appeal. On balance Ukraine now seems to be on the front foot in that process.
The first victory for Ukraine is not having to pay the $40 billion counter claim by Gazprom in the first take or pay gas supply case. This would have likely been terminal for the Naftogaz company, given that this amounted to the equivalent of over 50% of Ukraine’s GDP. It would have caused great flux at Naftogaz. There was talk of bankruptcy in such a case, which would likely have set back reform efforts at the company, and caused significant political flux.
In theory Naftogaz could now secure an award of damages on the first supply case of over $17bn. This award is set to be determined by the end of June, perhaps a little later if Gazprom appeals. The second transit case, where Ukraine is also claiming damages of over $17bn is expected to be determined by the autumn.
In a best case for Ukraine, Naftogaz, and Ukraine, by effect through the state-ownership of Naftogaz, could secure an award for damages now of anywhere from zero to $35bn. A figure of $35bn is equivalent to around 40% of GDP – close to half the country’s public debt, and twice its foreign currency reserves. It is also close to equivalent to the Western financial support package for Ukraine agreed in 2015.
Many Ukrainians have called for a Ukrainian Marshall Plan, for a similar amount to this number. So it would be ironic that in effect Russia, via Gazprom, could now be footing that particular bill. Maybe they should call it the Medvedev Plan for Ukraine. The award could likely be significantly less than $35bn, but even if it ends up being in single digits, for cash-starved Ukraine any amount --say above $2-3bn -- is still materially significant. $2-3bn would cover one year’s annual budget deficit at the current time. And, importantly, Ukraine does not have to pay the counter suit of over $40bn, which would have been impossible to pay.
This is a huge victory for the current management of Naftogaz (Kobolev/Vitrenko) who have done a remarkable join in transforming the fortunes of Naftogaz over the past 2-3 years. Through domestic price liberalization and efficiency savings, they have cut its deficit from 4-5% of GDP 3-4 years back to a surplus now. Importantly, they cut reliance on imported Russian gas, from 15-20 bcm a few years back to zero today.
The latter has seen the deficit on imported gas being reduced from $10-12bn a year during the Yanukovych era, to perhaps $2-3bn today, making for a marked improvement in the current account position of Ukraine.
But recently the reformers at Naftogaz have faced a political assault – with claims again of attempts at state capture by less reform minded forces in the administration. There have been concerns that the management would be forced out. This would be a huge loss for Ukraine’s reform momentum, as Naftogaz, alongside the NBU, are currently beacons of reform. As Kobolev said yesterday in the FT interview: "We won. We are the Champions!" I think that says it all, in terms of their own political position now.
Through this ruling, Ukraine’s disengagement from Russia continues, and Russia’s leverage over Ukraine further reduces/erodes. Over the past 3 to 4 years Russia has already seen its trade turnover with Ukraine drop from around 40% (of Ukraine’s turnover) to around 10%. Remaining state owned Russian banks are heading to the exits. Energy dependency has been radically reduced. Russian TV/social media influence is also fading fast. The latter recently helped by SBU actions over Yandex et al.
There is talk/fear of some Trump – Putin deal to put Ukraine back in Russia’s sphere of influence. But irrespective of that, Russia’s de facto influence over Ukraine has collapsed since the annexation of Crimea and the failed military intervention in Donbas. So even if Trump agreed to put Ukraine back in Russia’s sphere of influence, I don’t see how Putin can actually deliver on that. Ukraine seems to be lost to Russia for a very long time now -- at least under the rule of Putin.
Interestingly -- and I know many Ukrainians would not like me saying this -- this ruling is a victory also for Yulia Tymoshenko. She signed the original contract, and ended up going to jail as a result -- one of the few Ukrainian politicians to go to jail, and actually for something she did not do. In the end, with hindsight, the agreement was not as bad some had implied – and as affirmed surely now by the Stockholm Arbitration court.
A defeat would likely have been a terminal blow to Tymoshenko’s political aspirations. She would have taken flak for any large bill put at Naftogaz’ doorstep. But with this ruling she remains in the game (of Thrones). She currently is running neck and neck with President Poroshenko in opinion poll ratings as the country begins to focus on the 2019 presidential elections. Tymoshenko seems to be a cat with nine or more lives – and a politician who can never be ruled out.
One caveat in all this is the question of Russia’s reaction. The reaction yesterday from Moscow was muted. Partly this was sheer shock at losing a case which they thought was cast iron in their favor. I think that while Gazprom will likely challenge the Stockholm ruling, this challenge could be relatively short lived. And I do think that Gazprom will eventually be forced to pay up – largely as it has the cash means to pay. It has plenty of offshore assets to be attached. I think it would not want to risk reputational damage by not paying in a ruling over a pricing/supply contract. This is quite different say for example over the Yukos case in this respect which had quite different origins.
The bigger question for me is the politics of all this from Russia’s perspective. Clearly this was a huge political blow to the Kremlin – which I don’t think they were expecting.
For those questioning whether this was a political case from the Russian side, the question to be asked is: would Russia have lodged the case if President Yanukovych had still been president? I will leave you to make that determination. But will Moscow sit back and allow this to roll over them without some counter-reaction in the political or security field? As noted above, Russian leverage now over Ukraine in the economy/banks/energy sector is very limited.
Likely Moscow will further move to cut Ukraine out of the gas transit business, with plans to cut gas transit through Ukraine from 50-80 bcm in recent years (120+ bcm at peak) to 15 bcm from 2019, when the current gas price agreement ends. That said, Moscow’s options therein are still limited by Ukraine’s assets in terms of gas storage facilities in the West (28 bcm) which enables Gazprom to ensure constant supply to European consumers through the peak winter months - north and Turkish stream projects just don't allow that. Ukraine is learning to live without Russian gas, and gas transit – buying gas from Europe, and thinking of options of routing gas from the Black Sea, up through Europe.
Big win for Ukraine! That's bigger than the Eurovision song contest.
Very positive for Ukraine. As someone pointed out, this is 1:0 to Ukraine. But they are going for the golden goal now with the transit ruling expected for September. If Ukraine loses that one, it is 1:1, but if they win, it is 2:1 to Ukraine, and that could still be a multi-billion dollar settlement.
The interesting thing is that if Naftogaz wins the second ruling and gets awarded damages, Gazprom has offshore assets to attach. And Ukraine will go after payment, that's for sure.
Fair to say that with this ruling, Russia's "leverage" over Ukraine has further eroded. Over past 3 years, we have seen that in trade -- from 40% of trade turnover, Russia down to around 10%; banking/finance (withdrawal of Russian banks); energy (zero gas imports from Russia over past year; from 40-50 bcm a decade ago); social media (RU social media sites taken down). Only military options left, and even there Ukraine has boosted its military capacity.
Guess the Russians might counter. Ultimately Ukraine will be the loser as Russia continues to cut Ukraine out of the gas transit business, reducing gas transit through Ukraine to 15bcm from 2019 -- through the development of north, south and Turkish stream pipelines -- from the peaks of 120bcm plus a decade ago.
Also a major win for the reform management at Naftogaz (Kobolyev/Vitrenko et al), who have been under huge political pressure in recent months.
To be honest, I don't think many people expected Ukraine to win this one. So it is a major positive surprise, with more to come in terms of the transit ruling expected in the fall. This could deliver damages to Ukraine, if they win.
Posted June 1, 2017
Summary of the issues (written earlier on Wed):
Interesting case - which the market seems to be struggling to understand. Low visibility in terms of implications in terms of most people I have spoken to.
It seems the legal ruling on the winner/loser will be today, then by the end of June in the case of Ukraine losing there will be a determination of the size of any award. I guess this could be anything up to the mid-$40 billion level, as per the claim -- equivalent to more or less 50% of Ukraine's GDP.
The separate transit case, lodged by Naftogaz of Ukraine is expected by the fall. There, the award could be anything up to $17-18bn, assuming a ruling in Ukraine's favor. I am unsure how netting out would work. Easier for Naftogaz to collect on Gazprom's offshore assets (there are some) than the other way around, given Naftogaz reportedly has few. So I think Ukraine would prefer to keep the two sums separate.
A general view seems to be that even in a ruling against Ukraine's Naftogaz, there is likely to be an appeal. Even, assuming a failure, it will still be difficult to collect on assets in Ukraine through Ukrainian courts which are reluctant to comply in Russia's favor. Naftogaz still has other counter-measures planned, including perhaps a bankruptcy. Remember it does not own the underlying gas transit assets in Ukraine, which are owned by the government and leased to the company.
While it is easy to write all this off as being inconsequential, a ruling in Russia's favor will be exploited by Moscow to the full in the geopolitical and energy supply context. It could threaten to halt transit payments to Ukraine (~ $2bn a year, or 2.2% of GDP) in lieu of payment on any award. This would create a major financial hole for Naftogaz in terms of sustainability of the gas supply/transit business.
Moscow may also threaten to suspend gas transit through Ukraine to Europe - blaming this on Ukraine's unwillingness to abide by the Stockholm arbitration ruling. This could well come over the summer/fall lull in gas transit, when traditionally Ukraine is pumping gas into storage, to ensure constancy of gas supply to Europe for the winter.
Inevitably Moscow will look to link all this to Minsk II peace talks, and the resumption of Normandy format talks as well. Linked in there also may well be the on-going dispute on the $3bn December 2013 Eurobond also playing out in UK courts.
Interestingly, Russian "leverage" over gas transit to Europe, through Ukraine, is also diminishing, given that plans are to cut transit through Ukraine to Europe to only 15 bcm from 2019, when the current supply/transit deals ends. Presumably this will cut the gas transit fees to be offset against any ruling. In recent years, gas transit through Ukraine has dropped from the 115 bcm planned in the original contract to less than half this total.
This has come as Russia has pushed rival pipeline options - North stream, South stream, and Turkish stream, amongst others. That said, Ukraine still has the major advantage of having major storage capacity (28 bcm) in Western Ukraine, which enables it to better regulate/guarantee supply to Europe through the winter months.
Net-net, the most likely result of a arbitration ruling in Russia's favor, will be gas supply/transit tensions over the summer and into the fall, with Moscow looking to exploit all this for geopolitical advantage in on-going internationally brokered peace talks.
Timothy Ash is senior sovereign strategy analyst for BlueBay Asset Management in London
By Elena Mazneva and Daryna Krasnolutska
(Bloomberg) -- NAK Naftogaz Ukrainy expects that a
Stockholm arbitration tribunal will make a ruling Wednesday on a
gas dispute with Russia’s Gazprom PJSC in a case that includes
counter claims exceeding $80 billion.
The ruling is expected to cover legal and factual issues
required to resolve the parties’ claims while remaining issues,
including monetary demands, are seen addressed later in a final
award, Kiev-based Naftogaz said Wednesday. Gazprom didn’t
The two companies filed claims against each other over
Russian gas supply and Ukrainian transit contracts in place
through 2019 almost three years ago as relations between the
countries soured. Ukraine carries more than 40 percent of
Russian gas to the European Union across its territory, making
it a linchpin in the 28-nation block’s energy security.
Kremlin-backed Gazprom says it’s seeking more than $37
billion from its counterpart under the gas-supply deal,
including fees for fuel that Naftogaz didn’t receive but had to
buy under a so-called take-or-pay clause through 2016. An
arbitration award is seen on June 30, the exporter said in an
earning statement earlier Wednesday.
Gazprom shares fell the most in almost two weeks, sliding
1.5 percent to 120.26 rubles at 1:13 p.m. in Moscow.
Naftogaz says the Russian gas producer’s claim is about $46
billion. The Ukrainian company is also seeking some $18 billion
as a retroactive adjustment of the gas price it paid based on
The Ukrainian company also demands lifting its take-or-pay
obligations as the market situation and Ukrainian gas needs have
changed significantly since the deal was signed in 2009.
Naftogaz has coped without purchasing gas from Gazprom
since November 2015 amid the dispute, the longest it has gone
without supplies via Russia since Ukraine became independent in
1991. While similar conflicts disrupted deliveries to Europe,
which gets almost 15 percent of its gas needs from Russia via
Ukraine, during freezing weather in 2006 and 2009, transit to
Gazprom customers in Europe continues as normal.
Naftogaz has relied on its own production and flows through
pipelines from Europe, including of gas initially produced in
Russia. Gazprom has said it’s still delivering fuel to two
rebel-controlled regions in eastern Ukraine, which Naftogaz has
said it has no oversight over and won’t pay for.
In the transit claim, Naftogaz demands about $12 billion
from its Moscow-based counterpart as shipping fees have been too
low. Gazprom has also struggling with an antitrust case in
Ukraine which demands some $6 billion from the company because
it’s the only supplier of gas from the Russian territory.
While Gazprom has no sizable assets in Ukraine, the
nation’s justice ministry decided to freeze its 40-percent stake
in a minor special-purpose company called Gaztransit, the
Moscow-based company said in the earning statement. The firm was
set up in partnership with Naftogaz in 1997 to work on expanding
the Ukrainian gas network which hasn’t materialized. Gazprom
says its investment in Gaztransit is valued at 232 million
rubles ($4.1 million).