(Bloomberg) — About 60 miles from Ukraine’s border with the European Union, an array of pipes and pumps hints at what stands to become an important part of the bloc’s efforts to secure energy supplies and thwart Vladimir Putin.
Tucked between farm fields and forests, the Bilche-Volytsko-Uherske storage facility can stockpile more than four times as much natural gas as the largest site in Germany and connects easily to the bloc’s grids, thanks to Ukraine’s decades-long role as a transit route for Russian energy.
Storing vital fuel in a country subjected to missile strikes and attacks on critical energy infrastructure may sound like a crazy idea. But it’s winning backers as the facilities are far enough from the front line to be deemed safe, and some traders reckon it’s worth the risk.
In a sign of the concerns, German Economy Minister Robert Habeck issued a stark warning over the possibility of halting industrial capacity in the winter without Russian gas flowing through Ukraine, saying that policymakers need to continue to take precautions to secure energy supplies.
“We’re not yet out of the woods,” he said at an economic conference in eastern Germany on Monday. “The favorable situation mustn’t lead to us making the same mistake again of forgetting what the threat is.”
European officials are now contemplating whether to support links to Bilche-Volytsko-Uherske and other facilities scattered across Ukraine — home to the continent’s biggest network of underground caverns that can hold gas for when demand and prices spike in the winter. With EU sites already edging close to capacity — currently more than 70% full — storing the fuel in Ukraine could prevent a glut in the coming months.
“Ukrainian storage can help to balance supply and demand during the second half of the summer 2023, given their excellent connection to EU gas markets,” German utility RWE AG, which has used Ukraine’s storage in the past, said in a statement to Bloomberg.
To make storing gas in Ukraine viable, prices will need to fall low enough to justify the costs. The EU will also likely need to step in to provide a backstop against potential losses related to the conflict.
The evolving initiative is part of efforts to avoid the panic that led to record prices and state intervention last year. To shield companies and consumers, EU governments rolled out €646 billion ($694 billion) in aid, according to think tank Bruegel, and they can ill afford a repeat.
While European energy companies stored gas in Ukraine before Russia’s invasion in February 2022, putting supplies in a country involved in combat would normally be unheard of, and the deliberations reflect Europe’s narrow range of options and how the war has reset risks.
Energy has been a weapon in the conflict since the beginning. Last week’s explosion of the Kakhovka dam on the Dnipro River is the latest example. Last year, the Kremlin gradually squeezed gas supplies, creating havoc on Europe’s energy markets. Those concerns remain, and Ukraine is offering help.
Storing gas for Europe would not only generate much-needed revenue for the country, it would strengthen ties with the bloc and serve as a snub to Russia after the Kremlin sought to use energy to weaken support for Kyiv.
The country’s gas storage capacity — located in relative safety as much as 2 kilometers below ground — totals more than 30 billion cubic meters. Operator Ukrtransgaz is making available a third of that space — equivalent to about 10% of the EU’s fourth-quarter demand last year.
“The Ukrainian market offers storage at a fixed cost rate, which makes gas storage in Ukraine a very attractive and competitive option,” said Marco Saalfrank, the head of continental Europe merchant trading at Switzerland-based Axpo, but noting that the risk needs to be low.
With the insurance industry steering clear of Ukraine, the extent to which traders are willing to stockpile gas in Ukraine depends on pricing and whether the EU is prepared to provide a backstop. Talks are ongoing.
For its part, Ukrtransgaz is working on implementing service guarantees to reduce war-related risks as it seeks to become “a power bank for Europe,” the company said in an emailed response to Bloomberg questions, adding that demand has surpassed its initial expectations.
Time is running short on getting a system in place. Europe’s storage sites are expected to reach capacity limits as soon as early September. Heating demand typically doesn’t kick in until later in the fall, creating risks of oversupply, which could then whipsaw if a cold snap sets in.
Without Russian pipeline deliveries — which have largely ceased — European gas markets are more finely balanced than in the past. That means surges in demand or disruptions to supply can have outsized impacts.
The use of Ukraine’s facilities would help avert a crash in prices ahead of the winter, but if the usage is “unexpectedly high,” it also presents downside risks to rates next year, according to consultants Energy Aspects Ltd. Winter contracts are trading at a premium to summer prices, making storage in Ukraine or on tankers at sea an increasingly attractive option.
Swiss trader Axpo stockpiled gas in Ukraine before the war and is open to doing so again, but it’s keeping a close eye on developments and government guarantees will be key.
“Since the start of the war, the risks related to energy infrastructure in Ukraine have increased tremendously, as we’ve unfortunately seen with the recent dam explosion,” Saalfrank said.
