Ukraine as a key to Europe’s energy security - US-Polish-Ukrainian LNG/natural gas trading platform

Mykola Voytiv, head of energy projects of Kyiv based NGO, New Generation Management.

On August 31st 2019 a Memorandum of Understanding was signed in Warsaw to strengthen gas security in the region through LNG supplies from the US via Polish and Ukrainian infrastructure. This formal document may lay the foundations for developing a new natural gas trading market in Europe.

Free of political barriers, access to a diverse range of energy sources is necessary for effective industrial development. European economies have become increasing concerned with energy security. This is largely the result of growing desires to end a dependence on supplies of gas and oil from the Russian Federation. The diversification of energy sources guarantees supply and promotes market liquidity.

What actions should be taken in order to ensure this diversification? Will the Ukraine-Poland Interconnector and Baltic Pipe be able to guarantee a continuous supply of gas to the Polish and Ukrainian markets? What are the challenges faced by companies which manage infrastructural projects in the natural gas sector?

Ukrainian domestic gas production peaked at 68.1 billion cubic metres in 1975. It could be argued, then, that the country has the capacity margin to increase its national production. According to the Ukrtransgas, which operates Ukraine’s natural gas pipelines, gas consumption in Ukraine last year amounted to 14.4 billion cubic metres for industry and 15.4 for households and district heating companies. As of today, national gas production is about 21 billion cubic metres.

 Visible reforms

Ukraine’s gas market is showing signs of reform and development. These changes aim to create a well-functioning market and a regulatory environment that is compatible with the European Union’s gas sector and regulatory space. The reform’s key objectives are as follows:

  • The creation of a competitive market in the interests of consumers;
  • The reduction in specific rates of gas consumption to the level of Central and Eastern Europe;
  • An increase in domestic gas exploration and production;
  • Integration of the Ukrainian transmission system operator into the ENTSOG (European Network of Transmission System Operators for Gas);
  • The transformation of the country’s natural gas transit capacity into a multidirectional, flexible system possessing security of supply;
  • Promoting transparency among operators of natural gas distribution systems.

In relation to these goals, the reform’s achievements are already clear. Ukraine has closed direct connections with Gazprom natural gas supplies and has switched to European traders. The market has opened up for new international traders and suppliers, while gas production is looking for more investment. The Ukrainian gas market is now tightly linked to the EU gas market and in particular Poland. Ukraine recently received its first deliveries of LNG from the United States via the country.

Indeed, Warsaw and Kiev have many reasons to cooperate in the energy sector. Current priorities involve natural gas (LNG) trading and its storage in Ukraine. In 2019 Ukraine imported around 1.4 billion cubic metres of natural gas from Poland. This is more than twice as much as 2018. The approximate value of this ongoing gas delivery is around 350 million dollars per year. This increasing trade of natural gas between Poland and Ukraine has only strengthened plans to construct an interconnector. However, Kiev must approach this development strategically and continue to build the necessary transmission infrastructure. The ultimate goal of this project is to connect Ukrainian and Polish gas networks. This will help diversify Ukraine’s gas supplies and strengthen the integration of transmission systems and markets in Eastern Europe. If this happens, the value of this market will increase from 800 million dollars to one billion dollars per year.

Storage and supply

Another important step will be increasing access to Ukraine’s underground gas storage. The country today operates 12 sites with a total active capacity of 31 billion cubic metres. These provide gas storage for both suppliers and consumers. Ukraine’s underground gas storage is still the largest in Europe. Their location, on the border with the European Union (less than 100 kilometres from the EU border), would allow for gas to reach consumers within a few hours. Approximately 81 per cent of the underground storage’s capacity is located in the western part of Ukraine (five sites are located in Lviv and Ivano-Frankivsk Oblasts), which equates to around 25 billion cubic metres of gas. Using this infrastructure, Ukraine should be able to participate in further co-operation with the EU. Despite this, the creation of a Ukrainian gas hub at this point remains a project for the future. The idea was repeatedly voiced by Europe’s energy ministers, but no concrete steps have been made. It is clear that simple support will not be enough to make this proposal a reality. Ministers will have to commit all their time and resources to the project.

The LNG issue

Poland’s LNG imports (via the Świnoujście terminal) began with deliveries from the United States in July 2019. The volume of this flow is only set to grow in the next 24 years. Ukraine announced its desires to build an LNG terminal almost simultaneously with Lithuania’s project. The project “LNG Ukraine” started in August 2010. On November 26th  2012 in Yuzhny, the construction of an LNG terminal began and continues today. Officially delays to this project are due to international legal issues. Apparently, LNG tankers are not allowed to pass through the Bosporus Straits (even though carriers with liquefied gas propane-butane and hydrogen nitride do pass through). The more likely answer, however, is that Ukraine’s LNG terminal near Odesa is not operating for political reasons.

The budget of the Lithuanian LNG project was 128 million dollars. It has already provided Lithuania with gas and now allows the country to completely bypass Russian gas supplies. Today the country even supplies gas to Latvia, Estonia and Finland. Preliminary figures regarding the budget available to Kiev’s LNG project were over one billion dollars. It remains unclear as to why such a large amount of money was viewed as necessary for the project. However, comparing the capacity of both terminals (four and ten billion cubic metres of gas per year for the Lithuanian and Ukrainian projects, respectively), the Ukrainian terminal should cost around 350-400 million dollars. Even with a price tag of over one billion dollars, however, since 2012 there have been investment proposals from the United States, Australia, Qatar and the EU.

The estimated capacity of Ukraine’s LNG terminal is around 10 billion cubic metres of gas per year. This is slightly more than a third of what Ukraine needs on an annual basis. Taking into account the fact that the country extracts about 20 billion cubic metres of gas per year, it appears that Ukraine could even provide others with the surplus.

Trading Platform

In August last year a Memorandum of Understanding to enhance the security of regional gas supplies was signed in Poland. This agreement may lay the foundations of a new natural gas trading market in Europe. The US is now the world’s third largest seller of LNG, with exports of about 200,000 tonnes of LNG per day. Washington desires to become the largest LNG exporter in the world by 2023. It follows from the dynamic of the USA LNG import, which is increased 5 times from 2018 (8400 tonnes/day) to 2019 (42000 tonnes/day).

The European gas market may triple imports within the next five years. Given these prospects, the potential creation of a US-Polish-Ukrainian LNG/natural gas trading platform could significantly change the European gas market.

For Ukraine, developing such a platform would have additional benefits. For example, its national energy sector could potentially be integrated into Europe’s own energy efficient market, which may allow the country to become a major regional player. At the same time, the country’s partners would find it easier to access Ukraine’s sources of natural gas. This may subsequently help attract foreign investors to the country’s energy infrastructure. Such a platform could also operate in either the US or Poland in order to ensure the complete transparency of transactions.

There are also expectations that such a project would allow for Romania to export greater amounts of natural gas to Ukraine, as well as the expansion of transmission capacity between Ukraine and Slovakia. Due to this, a US-Polish-Ukrainian trading platform could unite markets in Hungary, Poland, Romania, Slovakia and Ukraine. Such a regional market would be able to process transactions of four billion dollars a year. It is unclear when the Baltic Pipe project will start, but it is possible that Norwegian and Danish trading companies could also be interested in this new trading platform.

In Ukraine’s New Energy Strategy 2035, the year 2020 is set as a deadline for creating a gas market in Ukraine. In addition, the government has planned a lot for 2019-20. Gas and electricity production should reach volumes that will allow the country to completely abandon imports. Looking at the gas market in Ukraine today, it appears that it only works in the industrial sector, although even now there is an opportunity to choose suppliers.

Undoubtedly, the gas market needs to be deregulated so that businesses can make money. If the gas market helps to increase liquidity, it will become more attractive for both national and foreign investors. However, the creation of a gas market should be primarily aimed at Ukrainian consumers, in order to make the country’s natural gas sector more transparent, more profitable and less deregulated.