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New Ukrainian president faces key, time-critical Russian gas challenge

Ukraine has elected comedian Volodymyr Zelenskiy as its new president, with the country's future as a transit country for Russian gas very much in the balance.

New Ukrainian president faces key, time-critical Russian gas challenge

While widely expected, Zelenskiy's election raises as many questions as it answers given his lack of political experience and his reluctance to reveal any detailed policy positions on major issues -- such as the country's relations with Russia in the gas sector.

Zelenskiy will have to manage a critical period for Ukraine as it seeks a new deal with Russia on gas transit to Europe ahead of the expiry of Naftogaz and Gazprom's 10-year gas agreement at the end of 2019.

"There is still a great degree of uncertainty over what Zelenskiy's administration will look like," said leading gas analyst Simon Pirani from the Oxford Institute for Energy Studies.

With as much as $3 billion/year in gas transit revenues at stake, Zelenskiy will be tasked with trying to push through a deal with Moscow while at the same time maintaining a strong stance vis-a-vis the Kremlin given the ongoing conflict in eastern Ukraine.

But with Ukrainian parliamentary elections due in October - which could see a new Ukrainian government come to power - Russia's stance may be to hang tight.

"Russia may choose to await the outcome of the parliamentary elections in October before deciding on its course of action regarding gas transit post-2020," Pirani said.

Transit 'Victory'?
Yaroslava Marusyk, an academic from the University of Groningen in the Netherlands, said that Zelenskiy's administration could be more compliant and conciliatory to Russia's demands in its gas negotiations with Ukraine.

Zelenskiy, she said, would likely see a deal with Russia over gas transit - even a short-term agreement - as a victory for the first half of his presidency. However, his team's efforts to secure existing transit volumes for Ukraine will not lead to Russia "deviating from its policy of gas transit diversification," Marusyk said.

Ukraine used to transit around 110 Bcm/year of Russian gas to the EU, but this fell to around 62 Bcm after Russia brought its 55 Bcm/year Nord Stream gas pipeline direct to Germany across the Baltic Sea online in 2011. Transit volumes have since recovered, though, and totaled 87 Bcm last year given high demand in Europe for Russian gas.

But Gazprom is looking to bypass Ukraine completely with the construction of the 55 Bcm/year Nord Stream 2 pipeline and the 31.5 Bcm/year TurkStream link, though some delays mean some kind of deal with Kiev will be necessary.

"Almost certainly, Gazprom will still need to transit some gas across Ukraine for the next few years, not least since Nord Stream 2 is not yet complete and the European extension of TurkStream is only just starting," said John Roberts, leading analyst with the Methinks consultancy.

"But it is highly likely that Russia will cease using Ukraine as a transit state at some time during the Zelenskiy presidency, thus terminating a key source of government funds, unless some kind of tripartite agreement can be concluded," Roberts said.

EU relations
Cooperation with Brussels while navigating a path to continued Russian gas transit to Europe will remain a key task for Zelenskiy. The EU's Vice President for Energy Union, Maros Sefcovic, said in January he was confident that whoever the president was in Ukraine would continue to engage in negotiations on gas transit with a view to reaching a deal before the end of 2019.

In the meantime, the president of the European Council, Donald Tusk, said he hoped that Zelenskiy would continue to seek energy sector reform at home. "As president of Ukraine, you can count on the EU's strong support to Ukraine's reform path, including consolidating the rule of law, fighting corruption, maintaining macro-financial stability and pursuing the essential reform of the energy sector," Tusk said.

Ukraine is on the road toward increased gas market liberalization, including unbundling its gas transit activities into a separate legal entity. The International Monetary Fund has made market-driven utility prices a condition of its loans to Kiev, but according to sources, the IMF is also in the dark about Zelenskiy's policies around domestic gas market policy.

However, an agreement on Monday between the Ukrainian cabinet and Naftogaz to set the gas price at $305.50/1,000 cu m for households should see some renewed calm in the domestic gas sector, which has been dogged by arguments over gas prices.

The deal suits the political need for low prices at a time of relatively low gas prices across Europe. But, Roberts warns, a rise in European gas prices could be damaging to the new Zelenskiy administration.

"Should Ukraine find itself in another gas crisis with Russia, with a resulting surge in international gas prices, then President Zelenskiy could find himself presiding over a government that was hemorrhaging cash in order to keep domestic prices low," he said.