War is raging, but one must make money on oil and gas. Russian-Ukrainian interests

Although it may seem incomprehensible to some, the two countries engaged in a dramatic military conflict still maintain economic contacts. Moreover, not only anti-Kremlin Poland, but also pro-Moscow Hungary, sends fuel to Ukraine.

Ukraine only introduced a formal ban on the import of oil and other fuels from the Russian Federation just a month ago. Now there is talk that they will not renew the agreement with Gazprom regarding the transit of gas to Southern Europe. Although similar threats were made in 2019, economic pragmatism prevailed, and despite being at war, the contract remains in effect and valid for another year.

Most readers may be shocked, but the Kremlin diligently and regularly transfers money to Ukrainian accounts every month for the distribution of resources. And these amounts are multiple times higher than what Warsaw received for the same service.

For decades, Kyiv has had plans for energy independence. But each subsequent project turned out to be a huge flop. And although no one says it out loud, Russian gas – in a very veiled manner – has been fueling the Ukrainian economy since 2014, and Russian oil powers Ukrainian tanks.

Hungary pumps fuel for Ukraine

“From now on, fuel of unspecified origin, in other words, fuel from the Russian Federation, will not be able to enter the Ukrainian market. This is another important step in protecting our national interests and sovereignty,” thundered Mykola Kolisnyk, Deputy Minister at the Ministry of Energy of Ukraine in mid-May 2023.

How is it possible that such a decree appears only a year and a half after the start of the war (or rather almost 9 years since its beginning, as Ukrainians consider themselves in a permanent military conflict since 2014)?

Although Kyiv had long imposed an embargo on the import of fuels from Russia, it never checked the origin of the product sold by intermediaries. In other words, they turned a blind eye to Russian fuels. It was an open secret that not only large corporations profited from this practice but also Ukrainian citizens.

So the ban was spurious, but it was meant to at least give the appearance of independence from Russia. Only that such independence never existed. Prior to the war, almost all fuel imports to Ukraine came from the east and north. That is Moscow and Minsk. The reason was simply that these fuels were cheaper. Resources from this region satisfied up to 75 percent of the total demand.

10 percent came from the Lithuanian Mažeikiai refinery (owned by Poland), but it was transported through Belarus. ORLEN Lietuva had a 10 percent share of the Ukrainian diesel market (690 thousand tons) and an 11 percent share of the gasoline market (265 thousand tons) in 2021. After the outbreak of the war, supply routes had to be changed, which was not easy because the capacity of railways in Poland has its limitations. It’s also worth noting that there is a different rail gauge in our country and in the east.

Thus, three-quarters of the market had to be replaced. Deliveries by sea were no longer possible as the port in Odessa was blocked by the Russian navy. Poland played a significant role in this regard. Interestingly, besides Orlen, one of the major suppliers of legal fuel is the Hungarian state-owned giant MOL. Fuel (mainly diesel) is delivered to Ukraine via a pipeline from Tiszaújváros (the pipeline was built between 1976 and 1978, and there used to be a refinery in that city).

Interestingly, the crude oil supplied from Russia through Ukrainian territory ends up in the Százhalombatta refinery in Hungary. Therefore, Ukraine first charges Moscow for the transportation of crude oil and then uses that money to pay Hungary, who supplies the product made from Russian resources.

It is worth noting that Russia has destroyed almost all of Ukraine’s fuel depots and the refinery in Kremenchuk. In the past, a total of six refineries operated in Ukraine, but they were outdated and unsuitable for professional operation, and the only relatively well-functioning plant – in Kremenchuk – was “eliminated” by the enemy right at the beginning of the war. In practice, Russia deprived Ukraine of its own fuel base, but – it is worth emphasising – it never decided to attack international pipelines. Ukrainians also did not blow them up.

“It should be noted that regular fuel supplies to Ukraine are essential not only for transportation but above all for the normal functioning of citizens, cities, and everyday life,” explains Dr. Michał Paszkowski, Senior Analyst at the Institute of Central Europe and a columnist for the Polon portal. “Russia has destroyed a significant part of Ukraine’s power plants and power grids. So people rely on power generators that require diesel fuel.”

Intermediary network

The situation with gas looks even worse, for two reasons. The first issue is deliveries because while liquid fuels can be transported by tankers from the west and south, gas transportation requires pipelines. Secondly, the most crucial aspect is the availability and origin of the resource.

Before the war, Ukraine was totally dependent on Russian gas. Even if it bought gas from former Soviet Asian republics such as Uzbekistan or Turkmenistan, it was still entirely delivered through Russian territory. In such a situation, no European Union country, except for Slovakia, had access to Ukrainian gas supplies.
Ukrainian tanks can still run thanks to Russian oil. Photo shows Kharkiv region, 6 July 2023. photo: PAP/Mykola Kalyeniak
What’s worse, the structure of intermediaries in the gas trade was extremely unclear. In the 1990s, a company called INTERA played such a role between Gazprom and the Ukrainian Naftohaz, and from 2006 to 2009, it was the company RosUkrEnergo.

“According to the Russian-Ukrainian agreements that ended the gas crisis in 2006, two companies, RosUkrEnergo and UkrHazEnerho, were involved in the process of selling Russian gas to Ukraine,” explained Arkadiusz Sarna in his analysis for the Centre for Eastern Studies. “RosUkrEnergo was owned half by Gazprom and half by Ukrainian entrepreneurs Dmytro Firtash (45 percent) and Ivan Fursin (5 percent), while UkrHazEnerho was half-owned by RosUkrEnergo and half by Naftohaz.”

At that time, Ukraine received gas not from Russian sources but through Russia – gas from Central Asian countries. However, Ukraine did not directly buy it from Gazprom but from its intermediaries. The supply chain worked as follows: Gazprom, based on long-term contracts, purchased gas from the Central Asian countries. Then it resold the gas extracted from its own sources along with the Central Asian gas to the company RosUkrEnergo, which organised its transportation to the Ukrainian border. The gas was then sold by RosUkrEnergo to UkrHazEnerho, responsible for distributing the fuel in Ukraine.

Gas diplomacy

And most importantly, the Ukrainian economy has always been incredibly energy-intensive, making it very susceptible to fluctuations in the price of the resource. It is worth noting that Russia readily used gas as a tool of political pressure on Kyiv by either reducing its price (when pro-Russian forces were in power) or increasing it, or even blocking supplies (when there was a pro-Western turn, as in the case of the Maidan protests). However, the first such manoeuvres took place as early as 1992, shortly after Ukraine gained independence.

  All of this has led to the fact that even though Ukraine officially stopped buying Russian gas in 2014 (since the first aggression), in practice, it still buys it. Only through intermediaries and at a higher price.

“For years, countries like Austria and Slovakia have been reselling their surpluses to Ukraine,” explains Dominika Taranko, Director of the Energy and Climate Forum at the Union of Entrepreneurs and Employers. “However, Kyiv has to pay transmission costs, which, in the case of the contract with Vienna, could reach up to 30 percent of the total price.”

Profiting from transit

Next year, the transit agreement between Ukraine and Russia will expire. The Ukrainian Minister of Energy announced that the renewal of a five-year transit contract for deliveries to Europe is unlikely.

But similar declarations from the Ukrainian side were made five years ago. At that time, the negotiation drama lasted until the last moment, as the contract extension was signed just 24 hours before its expiration. Of course, the European Union played a significant role in this, as in 2019, it lobbied for a positive outcome of the talks.

Despite the current situation being completely different and a significant portion of EU countries becoming independent from Russian gas, there are still countries that cannot imagine functioning without it. The gas pipeline passing through Ukraine supplies about 95 percent of Slovakia’s demand and almost half of Austria’s demand (which are the countries from which Ukraine has been buying gas for years, allegedly not originating from Russia).

The West is doing everything possible to source energy from alternative sources. They have reached an agreement with Azerbaijan to increase supplies from Baku. Maritime gas terminals receive a significant amount of gas from the USA and Qatar. That said, Russian resources are still the cheapest.

It is worth adding here that for many years, Ukraine earned much more from energy transit than, for example, Poland. According to experts’ calculations from the beginning of 2021, “Poland receives the least amount among European countries for the transit of Russian gas. Ukraine earns 2-3 billion dollars annually from transit, while we receive a fraction of that amount.”

Dr. Paszkowski says that the exact figures are considered confidential, but from time to time, estimated amounts like the ones mentioned above appear in the public domain.

Will the devastated Ukrainian economy easily give up on easy money from Moscow?

Failed attempts

And the most important question – is Ukraine truly ready to realistically separate itself from resources from the East? Because despite assurances from the country’s top officials about energy independence, according to the Energy Security Index prepared by experts from the Jagiellonian Institute, Ukraine ranks last among all European countries in terms of energy carrier security (including natural gas, coal, crude oil, and motor fuels). It fares almost twice as poorly as Bulgaria, which is equally dependent on Russia.
This independence from Russia has been raised multiple times in Ukraine. The construction of a terminal to receive liquefied gas on the coast of the Black Sea was announced as early as 2010, which is 13 years ago. Despite the project being approved in August 2010, construction has not even begun.

Two years later, there was a boom in shale gas production. Dutch giant Shell even decided to drill in the Kharkiv and Donetsk regions but eventually withdrew from its plans.

At the same time, another oil giant, ExxonMobil, embarked on conquering the Black Sea shelf to exploit the Skifska deposit (in Ukraine’s territorial waters). This involved both gas and oil. However, it ended only with test drilling.

Today, there is much talk about Ukraine investing heavily in renewable energy. It still has significant nuclear potential, and it can finance its development through the extraction of rare earth elements. And nobody knows how long the war will last, not only with Russia but also with its own weaknesses.

Because today, “the scale of coercion, corruption, and impunity of state officials is currently the highest in history,” warns the Federation of Ukrainian Employers. Such a situation is the biggest enemy of a healthy economy and effective economic reforms. But that is a topic for a completely different article.

– Karol Wasilewski

TVP WEEKLY. Editorial team and jornalists

– Translated by jz
Main photo: The Polish section of the construction of the Orenburg Soyuz Gas Pipeline near Kharkiv, Ukraine, a joint investment of the Council for Mutual Economic Assistance in 1976. Photo: Mariusz Szyperko
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