Amidst speculation that preceded the signing of the agreement, the presidents of both countries declared on January 11 2006 in Kazakhstan that both sides did indeed arrive at compromises in a mutually satisfying agreement, and declared that they would more work of cooperation in other areas of conduct of the neighbour countries.
A new gas dispute arose in October 2007 and it culminated with the gas reduction in March 2008.
Ukraine consumed around 80 billion cubic meters (bcm) of natural gas a year in 2004–2005. 20 bcm of that were of Ukraine's own production, around 36 bcm were bought from Turkmenistan, and about 17 bcm were received from Russia as a payment for transporting Russian gas to Europe. The remaining 6-7 bcm were purchased from Russia. According to the CIA's World Factbook 2005, Ukraine is the 4th largest importer and 6th largest consumer of natural gas in the world. This is partly due to waste and inefficiency of industry dating back to the Soviet times.
Russia supplies about 8 % of Ukraine's annual gas requirements. This gas had been supplied at heavily subsidized prices - about US$50 per 1,000 cubic meters compared to the market rate of about US$230 per 1,000 cubic meters. Note, however, Ukraine charges Russia transit fees for gas Russia passes through the Ukrainian gas pipeline network to Western customers. Transit fees were taken in the form of gas, with Ukraine taking 15 % of gas passing through their pipes.
It was noted by Pascal Lamy of the World Trade Organisation that all Post-Soviet states that buy gas from Gazprom must pay today's market prices for their energy needs in order to improve the efficiency of their economies. Lamy recalled, that it would have been much easier to resolve the conflict if both Russia and Ukraine had been WTO members. Moreover, he added that the problem had arisen in the first place because neither Russia nor Ukraine have true market prices for energy resources, thus resulting in an inefficient energy uses amongst the states. He added that the incident would not have any influence over the acceptance of Russia into the WTO.
Andrei Illarionov, former economic adviser to Vladimir Putin dismissed in December 2005, noted in this respect that there was no such thing as a gas market prices, because there was no such thing as gas market.
On 8 December 2005, Russian President Vladimir Putin noted in his speech that household consumers in Ukraine get gas for lower prices than do household consumers in Russia, the country that sells gas to Ukraine. He noted that Russia subsidised Ukraine on the gas matter by the amount of US$1 billion a year from the Russian budget (money that Gazprom would have paid into the budget from its revenues) — given that 25 million Russians still live below the poverty line, such a load onto the Russian economy is more than questionable, Putin noted.
On 26 December 2005, Prime Minister of Ukraine Yuriy Yekhanurov confirmed that public-utility prices for gas are lower in Ukraine than those in Russia, and said that a change is to be made, although the officials of the public utility company Naftohaz Ukrainy, which is the supplier of gas for household and budget consumers, said that they are going to keep the same prices for households and budget-organisation in 2006 as they were in 2005.
According to the contract signed by Russian state company Gazprom and Ukrainian state company Naftohaz Ukrainy on June 21 2002, which was supposed to be valid to the end of 2013, the payment for the transfer of Russian natural gas through Ukrainian pipeline system had been made in the form of barter exchange – up to 15% of gas pumped through the Ukrainian territory was taken by Ukraine instead of payment for the transfer transport. Originally, the amount of gas to be shipped as payment for the transfer was supposed to be negotiated every year and to be fixed by inter-governmental protocols.
On August 9 2004 the two companies signed an addendum #4 to the contract, according to which the amount of gas given as a payment was calculated based on the tariff of US$1.09 for transportation of 1,000 cubic meters over a distance of 100 km and the price of the natural gas was US$50 per 1,000 cubic meters (approximately US$1.40 per million Btu, see Calorific value of natural gas). According to the addendum the price was not subject to changes until the end of 2009.
Gazprom argued that addendum #4 was only applicable provided that the two countries sign an annual Intergovernmental Protocol specifying the terms of gas transit. According to Gazprom, the addendum #4 becomes void as the annual Protocol had not been signed for 2006 under the required terms.
Initially, Russia insisted on a new contract in which Ukraine would be paying about US$160 per 1,000 cubic meters (approximately US$4.40 per mmBtu). However, under Ukraine's hesitations, on 14 December 2005 Gazprom demanded US$230 per 1,000 cubic meters (~ US$6.35/mmBtu) claiming that such a price hike would reflect the trends in the world markets. Some commentators point out that the notion of "world market price" is hardly applicable to natural gas, especially in the region where supplies are dominated by a state-controlled monopoly. Still, the market price for natural gas traded in NYMEX was significantly higher than many existing contract prices due to the price hike of oil and gas in 2005. As of January 2006, the price for natural gas on NYMEX was about US$10/mmBtu. The spot prices in Europe ranged from US$10 to US$20 per mmBtu. Existing Russian contract prices to most European countries ranged from US$110 to US$280 per 1,000 cubic meters).
Russia agreed that the tariff for transit should be also increased, but only to US$1.74 per 1,000 cubic meters/100 km. (Transportation tariffs in Western Europe in 2005 ranged from $0.9 per 1,000 cubic meters/100 km in Belgium to US$4.5 in Greece; in the most important transit countries the tariff were: US$2.5 in Germany and US$2.7 in Austria). However, there were no market prices for transit; they were formed by the specific service costs of a pipeline, and in the EU subject to national energy market regulators' approval.
Russia claims that Gazprom's subsidies to the Ukrainian economy amounted to billions of dollars. Russian President Vladimir Putin claimed that Ukraine has enough money in its budget to pay the market price: "This is a heavy burden for the Russian budget... The consumers in Ukraine are getting gas today for a much lower price than Russian citizens pay in their own country! And we still have about 25 million citizens, who live below the poverty line". Ukraine, however, contended that Russian demands violated the contract of June 21 2002 and the addendum #4 to it of August 9 2004. Gazprom insisted that both contract and the addendum #4 were not and could not be active without the annual Intergovernmental Protocol that is the base and that has higher legal status.
The 2005 negotiations for new contracts were conducted between Russian Gazprom and its Ukrainian counterpart Naftohaz Ukrainy. At first, the Ukrainian side staunchly opposed any gas price increases, proposing to pay for gas with weapon supplies, but eventually Ukrainian President Viktor Yushchenko agreed to some concessions, in which the price of gas would be gradually increased over time. He stated that Ukrainian industry would become unprofitable if the price of gas rose above $90. He also called for avoiding the politicization of the dispute, and expressed his confidence that the problem could be solved by economical rather than political means.
About 80 % of Russian gas exports to Western Europe were made through Ukraine. Russia stated that it would like to have a consortium company created from Gazprom and Naftogaz, while Ukraine opposed that as it would mean that it would lose control over its own gas pipeline structure. Some Ukrainian officials called for a review of the lease price Russia paid to Ukraine for keeping its Black Sea Fleet in Sevastopol, Crimea: Russia currently pays about $97 million per year for the lease. Ukrainian officials declared that the lease of the port facilities to Russia is underpriced and called for a complete valuation of inventory of the facilities, which as some suggest could be worth up to US$2 billion, while Russia resisted any discussions that might affect the conditions of the lease. There were speculations that the calls to reconsider the lease price were prompted by US pressure, especially since they were made within hours of the US State Secretary Condoleezza Rice's visit to Kiev on December 8 2005. Such reevaluation, if undertaken, would be equivalent to revocation of 1997 Russia-Ukraine treaty in which Russia acknowledges predominantly Russian-populated Crimea as part of Ukraine in the first place, so it is a sensitive issue with further potential repercussions.
Andrei Illarionov, then Vladimir Putin economic adviser, was offered by the Russian government to explain the price hike and other issues in the Russia-Ukraine relations as liberal economic policies, but refused to do so and resigned as this had nothing to do with liberal economic policies according to his beliefs.
Many (European and US) media and analysts saw the conflict as the Government of Russia 'punishing' the new 'orange' Government of Ukraine, who was considered more pro-NATO and EU than its predecessor. Gazprom say that that's nonsense, they just don't want to subsidize former Soviet republics. On April 3-4 April, 2006 Gazprom indicated it would triple the price of natural gas sold to Belarus after December 31 2006. Unlike Ukraine that time, Belarus has close political ties to Moscow and this action created doubts about the supposed political motives of raising Ukraine's fuel rates. However when the 'orange' Government of Ukraine was ousted later in 2006 and replaced by a new more Moscow-friendly Government lead by prime-minister Viktor Yanukovych, the price for 2007 grew up further to US$135 per 1,000 cubic meters (from US$95 in 2006). On the other hand, Belarus has agreed to pay US$100 per 1,000 cubic meters for 2007.
During speculation about the signing of the agreement, the presidents of the two countries declared on 11 January 2006 in Kazakhstan that both sides had indeed come, through compromise, to a mutually satisfying agreement. They declared plans for further cooperation. Gas supplies to Western customers have since been on agreed level. To date, this agreement appears to be in force but unratified.
On December 13 2005, Gazprom threatened that if an agreement about the new price is not reached before January 1 2006 10:00 MSK, it would cut off supply of natural gas to Ukraine. The next day, December 14, Gazprom stated unilaterally that the new price would have to be US$220-230 per 1,000 cubic meters. Ukraine claimed that such steps would violate the past contracts and brought up the possibility to resort to international arbitration. On December 19 2005, Ukrainian Prime Minister, Yuriy Yekhanurov, traveled to Moscow but was unable to reach any agreement on the prices. The next day, December 20, Yekhanurov stated that Ukraine would be able to do without Russian gas and urged development of energy efficiency technologies.
On December 26 2005, Yekhanurov stated that Ukraine had a contractual right for 15% of the Russian gas transiting to Western Europe in his interview to the Ukrainian 5 Channel TV company. This statement came largely in response to the Gazprom threat to resort to the Arbitration Institute of the Stockholm Chamber of Commerce should Ukraine engage in unlawful withdrawal of Russian transit gas. Earlier, Yekhanurov announced that Ukraine could refer the case to the Institute if the compromise is not reached. Both countries are signatories to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards since 1960, so a decision by the Stockholm Institute in the case would be legally binding. According to Ukraine's government, its transit arrangements allow it to siphon off 15% of gas moving through the country.
On December 29 2005 Vladimir Putin offered Ukraine a US$3.6 billion loan to cover the cost of transition to market natural gas prices. His Ukrainian counterpart, Victor Yushchenko, promptly rejected the offer. In the last days of 2005, European countries, which had stayed out of the dispute until then, began urging Russia and Ukraine to find a compromise. On December 31 2005, in a last-ditch effort to solve the dispute, Russian president offered to postpone the price increase until April 2006 if Ukraine immediately agreed to the new prices. Ukraine, however, rejected the offer.
On January 1 2006 Gazprom started reducing the pressure in the pipeline system ahead of the deadline of the Russian ultimatum set for 10:00 MSK. On January 2 2006 Russia accused Ukraine of stealing US$ 25 million worth of gas. This was promptly denied by Ukrainian officials, although they flatly refused to sign any documents that would allow comparison of the volume of gas entering Ukraine from Russia and issued from Ukraine to the EU.
It is worth noting that as supply reductions are known to be occurring, either Ukraine is siphoning off gas, or Russia is undersupplying and falsely accusing Ukraine of siphoning. To address the latter speculation, Gazprom has invited the Switzerland-based goods inspection and testing company SGS to record the amount of gas that is entering Ukraine's pipeline network.
The EU-Russia gas supply contract requires Russia to supply gas to the former USSR border. Therefore, if Ukraine steals from or blocks the pipelines, the EU could sue Russia for violation of the contract. Therefore, as soon as the pressure fell in the EU, Russia had no choice but to turn back on the supply to Ukraine on January 3 2006.
Despite Ukrainian reassurances to the contrary, many European countries saw an immediate drop in the supply of the gas:
The United Kingdom has expressed concern that there would be a drop in their supplies in the near future, though none had yet been reported. In response to these drops Gazprom announced that more gas would be pumped to Europe.
"On the very day it takes over chairmanship of the G-8, it cuts off supplies to Ukraine, which indirectly at least threatens gas supplies to Europe. It undermines Russia's credibility straightaway," said Christopher Weafer, chief strategist at Moscow's URALSIB Capital. On January 2 2006, "economic ministers of Germany, Italy, Austria and France warned the government in Kiev that their nations' "perfect relations" with Ukraine could be affected if it failed to deliver all of the gas meant for European countries. On January 3, Russian Prime Minister Mikhail Fradkov "asked the European Union Tuesday to influence Ukraine to ensure full and uninterrupted gas transit from Russia to EU countries. In response to Russian demands, EU Energy Commissioner Andris Piebalgs from Latvia warned Russia not to make out of EU a "hostage" of its dealings with Ukraine, "I don't think making the EU a hostage is the proper way. Austrian Minister of Foreign Affairs Ursula Plassnik criticised Russian action against Ukraine. On 4th January Poland presented the position of Visegrad Group countries alongside Austria during special meeting of EU devoted to the gas issue. The statement included the opinion that it is unacceptable to demand higher prices by blocking of gas deliveries and that the EU has to find other sources of gas besides Russia.
On January 4 2006 the two countries reached an agreement to end the dispute. The 5-year contract was signed, although with the prices set for the next 6 months only. In the deal Gazprom "secured the hefty price hikes it had been demanding, raising the cost for its supply" to US$230 per 1,000 cubic metres to Russian-Swiss company RosUkrEnergo, which after mixing it with two thirds of cheaper supplies from Central Asia will resell it to Ukraine at a price of US$95 per 1,000 cubic metres. The parties also agreed to raise the tariff for transit from US$1.09 to US$1.60 per 1,000 cubic meters/100 km which concerns not only the transit of Russian gas to Europe but also Turkmen gas through Russia to Ukraine. The agreed price would fluctuate with the market, according to a Gazprom spokesman. Most analysts see it as a face-saving deal as both countries announced they were fully satisfied with the result.
However some experts doubt that this deal is profitable for RosUkrEnergo. The company has to buy 16 bcm of gas from Russia at US$230 per 1000 cubic meters, 40 bcm from Turkmenistan and Kazakhstan at price of $60-65 per1000 cubic meters, and then sell this gas to Ukraine at US$95/1000 cubic meters. Besides, RosUkrEnergo has to transport 40 bln cubic meters of gas to Europe at price US$1.60 per 1000 cubic meters per 100 km, or US$1,920 million. Total expenses become US$2500 +US$3800 + US$1920 million, or US$8.2 billion. Revenues from selling the gas are just US$5.5 billion. Likely the loss of US$2.7 billion is compensated by some undisclosed agreements, possibly covering Ukrainian debt as well as lease of the pipeline. Another analysis shows that, depending on the price from Turkmenistan, assuming the transit revenue, RosUkrEnergo's breakeven point is around US$70 per 1000 cubic meters for Asian gas. At US$65 per 1000 cubic meters it could make a small profit.
After the agreement was settled, (then) ex-Prime Minister of Ukraine Yulia Tymoshenko said that she is going to sue Naftogas of Ukraine for the violation of state-interests of Ukraine. However, the leader of the Liberal Democratic Party of Russia Vladimir Zhirinovsky said that he is going to bring forth a parliamentary investigation because of the possible violation of state interests of Russia.
Many observers around the globe alleged that Russia's step was an act of political retaliation for Ukraine's moving out of Russia's sphere of influence and for its pro-Western policy. Others alleged that the move to increase gas prices during the winter season may be intended to decrease the popularity of the Ukrainian president and his NSNU party among the voters, before the parliamentary elections in spring 2006 or that it was a Russian attempt to win control over the Ukrainian pipeline system.
Russia rejected the accusation that there was any political motivation behind gas prices, pointing out the fact that the Russian ally Armenia pays the same price as Georgia, which is known to have frosty relations with Russia. Russia contends that the move to higher gas prices is economically, and not politically, motivated and points out that other post-Soviet countries, such as Armenia, Georgia, Moldova, and the Baltic states, are also seeing their prices increased. However, the prices for Armenia, and the Baltic states remain in the much lower range of $110-125 per 1,000 cubic meters in the year 2006. According to Gazprom, the reason for that is said to be that the gas for Transcaucasia originates from gas fields that are not connected to the European market and thus there are no opportunity costs for Russia for not selling this gas to Europe. Concerning the Baltic states, Gazprom pointed at some infrastructure units in common possession as well as the timely signing of agreements on transient prices when the difference with European prices was not yet as high. Moreover, Russia does not have to offer the same prices to all its customers as long as it is not a World Trade Organization member.
In the Belarus case, lower prices are because Gazprom owns Belarusian pipelines and that it has a long-term lease of the land where the pipelines run. Because of this, as of 27 December 2005 contract, Belarus will be paying only 47 USD per 1,000 cubic meters in 2006. Gazprom pointed out the fact that a similar kind of deal was offered to Ukraine to keep the prices low, but was rejected. On March 30, 2006, Gazprom announced that Belarus will have to pay market prices for gas starting in 2007. From January 2007 Belarus pays 100$ for 1,000 cubic meters, while Ukraine pays 135$, Germany and other EU countries paid an average of 280$ in 2007 .
Earlier this year Gazprom declined Turkmenistan's offer to buy natural gas at $58 per 1,000 cubic meters as too expensive, in December 2005 it made an unexpected deal to buy additional 30 billion cubic metres of gas at $65 (with 15 billion cu metres to be delivered in 1Q2006). Many observers say that was done to limit Ukraine's options to seek alternative sources of the gas. While that may be the motivation, one should note that oil and gas price doubled during the year of 2005. At the same time Russia openly admitted it had limited Ukraine's access to the gas that Ukraine had been importing from Turkmenistan (it should be noted that Ukraine never bought gas directly from Turkmenistan, but always through Russia, the more so there is no common border between countries).
Some observers point out that it is hard to regard economic motives as being the basis for Gazprom's behaviour, since Gazprom's behaviour is economically inconsistent, while it is possible to regard political motives as the basis for Gazprom's behaviour, since it is largely state-owned and the prices it charges seem to correlate with the political relationship of Russia with the purchaser (although Armenia, which is politically friendly to Russia, still gets the same price as the rest of the less-politically friendly Transcaucasia, thus Moscow denies the claim that political friendliness plays a role in the formation of the prices). On the other hand, the price offered to Ukraine is still lower than that to Romania, and to EU, since transport cost to Ukraine are significantly lower than to Western Europe. (For EU, there was long term contract dated back to 1970s which helped to lower the average price.) Therefore, one could also argue that Russia is offering a discount to market price to Ukraine. It is the deal with Belarus, not the one with Ukraine, which is at a deep discount, which is politically minded.
Some analysts attributed Russian actions to the start of a parliamentary election campaign in Ukraine, in which the pro-Western forces were bound to face a challenge from opposition parties dedicated to tightening Ukraine-Russia relations.
At the end of February 2008, Gazprom threatened to reduce the supply of natural gas to Ukraine from March 3 2008, unless the pre-payment for 2008 had been paid. The Ukrainian government said it paid the gas bill for 2007 but still has refused to pay the bill for 2008. A Gazprom spokesman claimed that 1.9 billion cubic metres of gas deliveries worth about 600 million dollars still wasn't paid. Ukraine disagrees with a debt that accumulated in recent months when Russia used its own gas to make up for a shortfall in less expensive Central Asian gas. 3 March 2008 Gazprom cut it's shipments to Ukraine by 25% (a day later with another 25%), claiming that the US$1.5 billion debt still wasn't paid, Ukraine officials said it had been paid. Gas supplies where restored march 5 after Gazprom CEO Alexei Miller and Naftogaz Ukrainy CEO Oleh Dubyna agreed during negotiations by phone on a settlement to the crisis with gas supplies to Ukraine. On March 6 the Ukrainian cabinet refused to execute the gas agreements the President of Ukraine Viktor Yushchenko had reached with President of Russia Vladimir Putin. The government doesn't want to pay in advance for 2008 and it opposes the creation of Naftogaz-Gazprom venture that would sell gas in Ukraine. Prime Minister Yulia Tymoshenko stated that "Ukraine doesn’t need any additional newly created joint ventures. As of March 1, UkrGazEnergo will no longer be operating on Ukraine’s domestic gas market, the costs (for gas consumed in January and February) will be paid directly to RosUkrEnergo. But for January and February we are ready to transfer the money to wherever we agree with Gazprom, so that it’s convenient for Gazprom”.