Ukraine wins in gas dispute in Stockholm tribunal against Russia; but victory may be hollow

In a conflict in which Ukraine repeatedly claims victories which in reality turn out to be defeats, Ukraine did win finally win a genuine victory over Russia at the Stockholm Arbitration Tribunal on Wednesday 28th February 2018.

The victory came in the litigation between Russia’s monopoly gas exporter gas exporter Gazprom and Ukraine’s national gas company Naftogaz.

After having previously rejected all of Naftogaz’s arguments against the legality of its gas supply contracts with Gazprom, and after having ordered Naftogaz to pay Gazprom $2 billion for unpaid gas, the Stockholm Arbitration Tribunal ordered on Wednesday 28th February 2018 that Gazprom owed Naftogaz $4.7 billion for its failure to supply agreed volumes for transit.

The $2 billion Naftogaz was previously ordered to Gazprom is set off against the $4.7 billion Gazprom is ordered to pay Naftogaz, ending the litigation with an overall award to Naftogaz of $2.54 billion.

The Russian news agency TASS has provided an account of the issues in the litigation

Gazprom vs Naftogaz dispute

Gazprom and Naftogaz signed the current contract for the supply of gas to Ukraine in January 2009 and it is valid until December 31, 2019. Under the contract, the volume of supplies was to be 40 billion cubic meters of gas in 2009, and starting from 2010 – 52 billion cubic meters annually. However, since 2012, Naftogaz failed to fully intake the contracted volume. Since November 2015, Kiev has not bought Russian gas, replacing it with reverse gas from Europe.

In 2014, Gazprom and Naftogaz filed lawsuits against each other in the Stockholm Arbitration.

Ukraine sought a retroactive price change, recovery of overpayment for gas and cancellation of the “take or pay” principle.

Gazprom demanded that Naftogaz should pay arrears for gas that had been supplied earlier. Gazprom’s demands for Naftogaz amounted to more than $37 bln.

The Stockholm Arbitration satisfied the requirements of the companies only partially.

In December 2017, the court ordered Naftogaz to pay Gazprom $2 bln for the deliveries, but reduced the annual contractual volume of purchases to 5 billion cubic meters.At the same time, the “take or pay” condition was preserved for 80% of this volume. This condition will be effective only in 2018.

The court also rejected most of Naftohaz’s claims to Gazprom which concerned overpayment for gas. Only the price of gas received by the Ukrainian company in the second quarter of 2014 was lowered (from $485 to $352 per 1,000 cubic meters). Naftogaz wanted a retroactive price change starting from May 2011.

In the gas transit contract, Naftogaz and Gazprom agreed that the Russian holding will pump 110 billion cubic meters of gas through Ukraine annually. However, the contract notes that the annual volume is specified in additional agreements to the contract, depending on the obligations of Gazprom to European consumers.

Naftogaz demanded that Gazprom should pay $17 bln for the failure to supply the agreed volumes for transit. It also sought the revision of tariffs and conditions for the transit of Russian gas through Ukraine.

The Stockholm court ruled that Gazprom should pay about $ 4.7 bln to Naftogaz (taking into account the satisfied counter claims, Gazprom has to pay $ 2.56 bln). At the same time, Gazprom said that the arbitration court rejected Naftogaz’s demands to increase the tariff for gas transit and change the contract in accordance with Ukrainian legislation.

This account does not give reasons for the Stockholm Arbitration Tribunal’s decision.  Alexey Miller, Gazprom’s CEO, has however explained it in this way

The Stockholm arbitration, guided by double standards, adopted an asymmetric decision on our contracts with Naftogaz of Ukraine regarding supply and transit of gas. The decision seriously violates the balance of interests of the parties under these contracts. The arbitrators ground their decision by the fact that the situation with the Ukrainian economy has drastically worsened. We are totally against the situation when Ukraine’s economic problems are solved at our expense. In this situation, the continuation of the contracts’ validity is not economically feasible and unprofitable for Gazprom

(bold italics added)

As a general principle, European commercial law tends to take a more interventionist and paternalist approach to commercial disputes than is the case in common law jurisdictions such as those of England and (most of) the US.

A decision which in effect rewrites a contract for the benefit of a weaker party would not therefore be wholly unprecedented, and an arbitration panel – which is not technically speaking a court – has more liberty to be flexible than a court does.

Having said this, if it is in fact the case that the Stockholm Arbitration Tribunal made such a large award in Naftogaz’s favour simply because Ukraine’s economy has deteriorated since 2009, then that would indeed be a very remarkable thing indeed, and Gazprom would in that case be justified in complaining about it.

After all, as Alexey Miller says, it is not Gazprom’s job to support Ukraine’s economy, and it is absurd to suggest that Ukraine’s economic problems – many of which are self-inflicted – should be solved at Gazprom’s expense.

Having said this, without publication of the actual reasons for the award – which is unlikely to happen – it is impossible to say for certain whether Miller is describing them properly.

Irrespective of what the Stockholm Arbitration Tribunal’s reasons for its decision were, Gazprom has has wasted no time in responding to it.

Firstly, it has rejected the decision.

This Gazprom is able to do because the Stockholm Arbitration Tribunal is an arbitration panel not a court.  If Ukraine wishes to enforce the award it must therefore convert the Stockholm Arbitration Tribunal’s decision into a court Judgment.

In most cases that is purely a formality.  However in this case it might not be straightforward if Miller’s account of the reasons for the Stockholm Arbitration Tribunal’s decision is true.  Many courts might balk at a decision which appeared to rewrite a contract in so radical a way and for such a reason.

There is also the issue of which courts would have jurisdiction in the case to convert the award into a court Judgment.

I do not know the answer to that question.  In order to answer it I would need to see the relevant contracts between Gazprom and Naftogaz.  I doubt that will ever happen because as I understand it the contracts are secret.

All I will say on the jurisdiction is that it is interesting that Ukrainian President Poroshenko is saying that if Gazprom refuses to pay the award Ukraine will enforce the award by seizing Gazprom’s assets in Ukraine itself.

That suggests either that Poroshenko believes that it is the Ukrainian courts which have jurisdiction in the matter, or that he is not confident that whichever other courts do have jurisdiction in the matter would agree to enforce the award by converting it into a judgment.

More to the point, Gazprom has signalled its total loss of confidence in the Stockholm Arbitration Tribunal by cancelling all its gas supply and transit contracts with Naftogaz, and by informing the Stockholm Arbitration Tribunal that it no longer considers it to have any further role in the matter.

In keeping with this decision, Gazprom has stopped supplying gas to Naftogaz, and has returned Naftogaz’s prepayment for the future supply of gas.

This has in turn triggered a short term gas crisis in Ukraine, which can no longer import gas from Russia to cover its own needs, but which is struggling to find alternative sources of gas in Europe, which is currently experiencing a gas shortage because of the recent cold weather.

In my opinion it is unlikely Naftogaz will ever see the $2.56 billion it has been awarded.

However against that Naftogaz and Ukraine have escaped paying the $2 billion it looked like they would have to pay to Gazprom just a few weeks ago.

Given Ukraine’s deteriorating financial and economic position the Ukrainian government probably calculates that a few days or even weeks of gas shortages is a small price to pay for escaping payment of the $2 billion to Gazprom, which in its present condition Naftogaz and Ukraine would struggle to pay.

As for the Russians, I suspect that privately they believe that Ukraine’s friends in the West applied backstairs pressure on the Stockholm Arbitration Tribunal when it looked like Naftogaz was about to lose the case to make what the Russians say is an illogical decision.

That will reinforce their decision to cut Ukraine out entirely as a transit state for their gas, regardless of whatever public assurances Putin may be currently giving to the contrary.