International arbitration News, analytics and practice

10Jun/101

Stockholm Court Rules Against Naftogaz Ukrainy in RosUkrEnergo Gas Arbitration Case

RosUkrEnergo, the controversial former intermediary in the supply of Russian and Central Asian gas to Ukraine, has won a key ruling in its arbitration case against Naftogaz, but the Stockholm Arbitration Tribunal has said that the cash-strapped Ukrainian state gas firm Naftogaz must restore 12.1 bcm of gas in storage to RosUkrEnergo rather than paying cash as compensation.

IHS Global Insight Perspective  
Significance The Stockholm Arbitration Tribunal ruling essentially restores ownership title to RosUkrEnergo of 11 bcm of gas in Ukrainian storage that the intermediary claimed was "expropriated" by Naftogaz in the aftermath of the political deal that ended the January 2009 Russia-Ukraine gas dispute and awards a further 1.1 bcm of gas in lieu of damages.
Implications The court ruled that Naftogaz (which has already been held responsible for paying US$197 million in damages to RosUkrEnergo), must provide this 12.1 bcm by 1 September, giving it nearly three months to pump additional supplies into storage and transfer title to this gas to RosUkrEnergo—or come up with another solution.
Outlook Although the arbitration court's ruling is a clear victory for RosUkrEnergo, the decision to award the company (a joint venture between Centragas and Gazprom) in gas rather than in cash means that state-owned Ukrainian firm Naftogaz—which could scarcely afford to pay several billion dollars in cash damages—has dodged a bullet that could have pushed it into bankruptcy.

RosUkrEnergo Triumphs in the End

Despite having its role as intermediary in the supply of Russian and Central Asian gas to Ukraine eliminated from the start of 2009, RosUkrEnergo (RUE) never really went away. The company, a joint venture between Russia's Gazprom and Centragas (itself a joint venture between Ukrainian businessmen Dmytro Firtash and Ivan Fursin), rose to prominence with its key middleman role in the deal that ended the January 2006 "gas war" between Gazprom and Naftogaz, but its position became untenable after Yulia Tymoshenko became Ukraine's prime minister in December 2007. Tymoshenko argued loudly for the elimination of RUE, securing agreement from the Russian government on a return to a direct trading relationship between Gazprom and Naftogaz from the start of 2009. However, the subsequent gas war that broke out in January of that year between Russia and Ukraine ended up with RUE caught in the crossfire. Not only was the intermediary left to fend for itself in claiming damages for late payments by Naftogaz dating to 2008, but the Swiss-based company then got squeezed in a complex addendum to the January 2009 transit contract between Gazprom and Naftogaz, which resulted in the Ukrainian firm essentially taking ownership of some 11 bcm of gas in storage.

Therein the seeds of a new dispute, this time between Naftogaz and RUE, were sown. According to the addendum, Gazprom transferred the right of recovery of a US$1.7-billion debt, owed by RUE, to Naftogaz. Tymoshenko effectively took this to mean that Naftogaz (which at the time was facing a price of US$360 per 1,000 cm for new gas supplies from Russia, double the price from the fourth quarter of 2008), could take title to this gas from RUE as payment of that debt, meaning that Naftogaz de facto "paid" a price of US$154 per 1,000 cm for the gas. RUE, however, claimed that Naftogaz expropriated the gas in storage, and that such a move was never part of any deal. The resulting transfer of title of this gas in storage prevented RUE from fulfilling the terms of its own export contracts with clients in Poland and Hungary. In the face of stiff resistance from Naftogaz and the Tymoshenko-led government, RUE then opted to press its case with the Stockholm arbitration court.

Yesterday, RosUkrEnergo was vindicated, as the arbitration court ruled in RUE's favour. Centragas released a statement saying that the arbitration court ruled that the 11 bcm of gas in storage was taken by Naftogaz in breach of its storage contract with RUE, further requiring that the Ukrainian firm return that amount to RUE on the same terms. In addition, the arbitration court awarded an additional 1.1 bcm to RUE from Naftogaz, in lieu of RUE's entitlement to penalties for breach of contract. Earlier this year, in March, Naftogaz was held responsible in an earlier phase of the arbitration case for paying RUE US$197 million in damages for various breaches of the supply, transit, and storage contracts. RUE said that in response to the ruling, it was withdrawing its legal action against the Ukrainian government under the Energy Charter Treaty, although the Stockholm court is still slated to rule on several minor remaining issues of dispute between Naftogaz and RUE later this month as well. Robert Shetler-Jones, the CEO of Group DF, the parent company of Centragas, said in a statement that the ruling was a "satisfactory and just outcome" of the dispute, vindicating RUE's determination to hold Naftogaz and the Ukrainian government accountable for their actions.

A Pyrrhic Victory?

Nevertheless, it is hard to dismiss the notion that Naftogaz has managed to escape the gallows with the arbitration court's ruling. Not only did the Stockholm tribunal give Naftogaz nearly three months, until 1 September, to return the ownership title to the 11 bcm of gas in storage to RUE, but the decision to make the damage award in gas rather than cash is something of a victory for the Ukrainian firm. Naftogaz, which has struggled for the past two years in paying its monthly bill for gas imports, could scarcely afford a multi-billion-dollar cash damage award, but will have an easier time of it in simply transferring title to gas in storage to RUE. For its part, RUE said recently that it would prefer to be compensated in the arbitration case in cash, suggesting that the firm was perhaps aiming to secure the value of the gas in storage at the time it was taken in early 2009 (which RUE put at around US$5.4 billion).

Receiving title to the gas in storage now is a mixed blessing for RUE, as the value of this gas (around US$2.8 million) is much lower at current European prices than it had been in early 2009. What is more, since it was unable to fulfil the terms of the gas export deals with Hungary and Poland in 2009, RUE no longer has any firm export deals for which this gas could be used. RUE said that it plans to make this gas available on the market and sell it for the best possible price, but its damaged reputation may make it difficult to find buyers in Europe, particularly with the market already over-supplied—a situation that has seen Gazprom agree to reduce minimum bill levels in its "take or pay" contracts with its European partners. Rather than restarting its niche gas export business in central Europe with the return of the 11 bcm of gas in storage in Ukraine, RUE may be left with limited opportunities to monetise these assets, perhaps in selling the gas directly to Gazprom or even back to Naftogaz itself.

Outlook and Implications

RUE's victory in the arbitration case is vindication for the intermediary, but the terms of the court's ruling mean that this is a heavily qualified win. Together with the March 2010 ruling—which saw Naftogaz held responsible for just a fraction of the US$3.4 billion in claims lodged against it by RUE—the Stockholm tribunal's decision to award RUE with gas rather than cash is tantamount to an 11th-hour death sentence reprieve for the state-owned Ukrainian gas firm. The April 2010 "fleet-for-gas" agreement between Russia and Ukraine that secured a 30% gas price discount for Naftogaz has helped stabilise the firm's finances, while the rulings by the arbitration court have now removed another black cloud that had been hovering over the company. Instead of racking up gas debts to Gazprom and potentially going bankrupt as a result of the RUE case, Naftogaz is now in a position to begin to look towards the future rather than dealing only in short-term crises.

Then again, the fears that Ukraine's former government (now in opposition) had voiced over a potential forced bankruptcy of Naftogaz—that the company and its prized gas transit system (GTS) could be taken over by Gazprom—could still be realised, albeit in a much more straightforward fashion. Ukrainian president Viktor Yanukovych has moved to restore political and commercial ties with Russia since taking office earlier this year, and although he has responded coolly to a proposal by Russian prime minister Vladimir Putin to merge Gazprom and Naftogaz, Yanukovych has not entirely dismissed the idea. Improved co-operation between the two gas firms has reduced the threat of a new gas war, implicitly serving to improve Europe's energy security. A potential joint venture between Naftogaz and Gazprom that could include the GTS is still on the cards as well.

The greatly improved relationship between Gazprom and Naftogaz, as well as the two governments, means that the potential for the outcome of the RUE arbitration case to generate renewed controversy was already significantly diminished. Indeed, this improvement surely gave Gazprom less incentive to push hard for a cash award in the arbitration ruling, which Shetler-Jones said represented a "fair and sensible outcome for all concerned". Naftogaz had only about 10–12 bcm of gas in storage as of end-April, of which 5 bcm is cushion gas, so the Ukrainian firm has just 5–7 bcm of gas available at present for which it could conceivably transfer ownership to RUE. Nonetheless, with nearly three months before Naftogaz must transfer the 12.1 bcm of gas to RUE, the Ukrainian firm has time to buy additional gas—from Gazprom, of course—and restock its gas storage facilities, something that it would have to do in any case in advance of the winter heating season. With lower gas seasonal gas demand in Ukraine and reduced import prices as a result of the discount to which Ukraine and Russia agreed in April, Naftogaz should be able to afford to buy enough gas to meet the 1 September deadline and meet its obligations to RUE under the court ruling.

Source: http://www.ihsglobalinsight.com