Ukraine's Deal with European Union to Modernize Gas Network Creates Tension with Russia

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Researched by Industrial Info Resources (Sugar Land, Texas)--Ukraine has signed a deal with the European Union (EU) to improve its gas network infrastructure, angering Russia in the process and adding a whole new dimension to the gas wars raging around Russia and east-central Europe. The deal was recently signed at an international conference on energy security in Brussels, Belgium.

Ukraine's 13,500-kilometer (km) long gas pipeline network is more than 40 years old and one of the most complex systems in the world, comprising 10 storage facilities and 70 compression stations. Although Ukraine estimates that nearly $5.5 billion is needed to increase its existing pipeline transmission capacity, the European Commission expects an investment of $3.4 billion to be required between 2009 and 2015 to revamp the pipeline infrastructure. Upon completion, the efficiency of gas pipelines is likely to improve by 25%. Currently, about 80% of the gas that Russia exports to Europe flows through Ukraine.

The agreement between Ukraine and the European Commission, the European Investment Bank (Luxembourg, The Netherlands), the World Bank (Washington, D.C.), and the Bank for European Reconstruction and Development (London) will facilitate the much-needed international financing to improve Ukraine's aging gas infrastructure. In return, Ukraine has agreed to operate its pipeline network with increased transparency.

Ukraine will upgrade gas compressor stations and plans to set up metering stations along gas transit pipelines. The country has agreed to allow access to its large underground gas storage systems and pipelines at nominal prices conforming to European standards.

Russia is furious over the agreement, as it has been excluded from the modernization project. The country has warned of disruptions in gas supplies to Ukraine because of increased technological risks. Russia is keen on being involved in the project, including financing aspects if required. The country has long advocated the leasing of Ukraine's gas transportation system. However, Ukraine has made it clear that it will not give up ownership of this strategic asset.

Nearly 20% of Europe's natural gas supplies come from Russia through Ukraine. The gas supply to 18 European countries was adversely affected during in January after Russia turned off supplies following a dispute with Ukraine over pending transit fee payments. The EU aims to secure energy supplies and plans to invest in developing alternate gas transfer routes from Russia. The EU is backing the Nabucco pipeline project, which will transfer gas shipments from the Caspian region to Europe though Turkey. The pipeline, designed to transport 31 billion cubic meters per annum of gas beginning in 2012, will run from Turkey to Austria through Bulgaria, Romania and Hungary.

Russia is also investing in several new pipeline projects to export gas to Europe with the intention of bypassing Ukraine. One such project is the 1,220-km long Nord Stream natural gas pipeline, which will link Russia and Germany through the Baltic Sea. The first pipeline, with a transmission capacity of 27.5 billion cubic meters per year, is expected to be completed in 2011 while the second line is slated for completion in 2012.

Construction of new gas pipeline networks bypassing Ukraine will require multibillion-dollar investments, an arduous task in the face of the current economic crisis and credit crunch. Ukrainian Prime Minister Yulia Tymoshenko has said that modernizing the country's existing pipeline infrastructure is comparatively a cost-effective option. The reliability and profitability of Ukraine's existing network has motivated the EU to invest in the project.

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