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Russia-Ukraine gas transit talks step in right direction, but barriers persist

London — Talks between high-ranking officials from Russia, Ukraine and the European Commission on Tuesday in Berlin over the future of the transit of Russian gas via Ukraine post-2019 were a step in the right direction after a period of stubborn impasse between the parties.

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But despite the process of negotiations now being underway, barriers to a meaningful outcome remain.

The implications of the likely deadlock could be far-reaching. If the two sides fail to agree new arrangements for the future transit of Russian gas via Ukraine to Europe before the contract expiry at end-2019, uncertainty over flows from Europe's biggest gas supplier could ensue.

There had been concern in recent months about Moscow's willingness to negotiate on future transit conditions at all, especially given the Russian appeal against the Stockholm arbitration court's ruling on the transit deal between Gazprom and Ukraine's Naftogaz at the end of February.

The court's decision to award Naftogaz a net $2.6 billion in compensation for Gazprom's under-utilization of the Ukrainian gas network was slammed by the Russian gas giant, which moved to cancel the 10-year supply and transit agreement altogether.

The EC-brokered talks came as welcome relief after the sometimes ugly tit-for-tats between Gazprom and Naftogaz in recent months over their ongoing legal disputes.

Following the meeting in Berlin, Russian energy minister Alexander Novak said Russia is ready to agree on a post-2019 natural gas transit contract with Ukraine and consider using that route to meet expected higher EU gas demand.

"I think we have to see it as a meaningful step to have established a process -- I thought it was a possibility that even that might be impossible," leading gas analyst Jonathan Stern from the Oxford Institute for Energy Studies told S&P Global Platts Thursday.

COMMERCIAL DEAL

Despite the breakthrough in holding talks, negotiations on reaching a deal on transit post-2019 after the Gazprom-Naftogaz accord expires are likely to go down to the wire as was often the case in contract renegotiations between the two companies in the 2000s.

Gazprom was clear in its response to the talks this week that they must not be classed as bilateral, commercial negotiations.

"The consultations that have taken place do not have the status of negotiations between companies," CEO Alexei Miller said.

Ultimately, it will require commercial negotiations between the two to resolve the outstanding issues -- something that may remain out of reach for now given the ongoing legal disputes that include Naftogaz moves to seize Gazprom assets in Europe to enforce the $2.6 billion arbitration award.

DISPUTE RESOLUTION

"I find it difficult to imagine that it will be possible to establish a lasting transit agreement while Ukrainians are attempting to seize Gazprom assets and both sides are pursuing multiple (and increasing numbers of) arbitration cases against each other," Stern said.

Gazprom -- in its reaction to the talks this week -- stressed however that any new transit agreement post-2019 required a settlement of the legal disputes first.

"The main issue that predetermines the future relationship between Gazprom and Naftogaz [on transit] is the settlement of disputes and restoring the balance of interests under the existing contract," Miller said.

Those disputes look far from being resolved, however. In June, Naftogaz chief commercial officer Yuriy Vitrenko conceded the arbitration process could prove to be "endless" given the number of legal claims, counter-claims, appeals and counter-appeals.

But one thing is clear -- remaining deal-less on December 31, 2019, would strike a severe blow to both companies' reputations with the cut off in the transit of Russian gas via Ukraine in 2006 and 2009 still fresh in the minds of Europeans.

"Both sides need a deal to be struck for ongoing transit post-2019 and there's not much time," Stern said.

"But a detailed agreement, which will include guarantees of volumes and tariffs sufficient to satisfy both parties, seems very difficult," he said.

Naftogaz CEO Andriy Kobolev said in May that Gazprom -- and any other shipper -- was free to book transit capacity after 2019 using a standard procedure for short-term capacity rather than a specifically negotiated long-term contract.

The procedure includes standard pricing, volumes and timeframes, and was developed by the Ukrainian regulator under Ukrainian law, with EU advice.

KEY ROUTE

Ukraine remains a key transit route for Russian gas to Europe, with Gazprom saying 10-15 Bcm/year of gas would need to move through the corridor from 2020 even if the 55 Bcm/year Nord Stream 2 and 31.5 Bcm/year TurkStream pipelines are operational on schedule.

Significantly higher volumes would be needed to be sent via Ukraine -- given the 94 Bcm that moved through the corridor last year -- if there is any delay in building the Ukraine bypass lines. In that eventuality, a robust transit deal needs to be in place.

While the other two main routes -- Nord Stream and Yamal-Europe to Germany -- are utilized at close to full capacity, Ukraine transit is crucial as it takes the swings from fluctuations in European gas demand and other source of supplies such as imports from Norway, Algeria and LNG, and Dutch production.