First, the prior contract on natural gas prices, which covered both gas and transit fees across Ukraine expired.

So Gazprom its Ukranian counterpart Naftogaz were negotiating, and then, because there was no deal on prices, Russia reduced shipments to the Ukraine but shipped more to the EU, on the far side of the pipeline, along with routing as much gas as possible via Belarus.

Russia then shut down the feed Ukrainian pipeline, because they said that the Ukrainians were stealing the gas, which has led to gas disruptions across Europe.

So they are now in negotiations, and there are a number of sticking points:

The first is that Ukraine wants to cut the contracted agent for the gas sales, RosUkrEnergo, because they believe it to be corrupt, which is probably true, but it also gives them the ability to monitor just how much gas enters the Ukraine from Russia.

The next big issues are over price. Ukraine was paying $179.50/tcm (thousand cubic meters) with a transit fee of $1.70/tcm/100 km, and has offered $201/tcm with a transit fee of $2.05/tcm/100km.

When you consider that a lot more gas goes through Ukraine than is used there, it sounds like a wash in terms of cost to the Ukranians.

Gazprom wants to keep the transit fee the same, and charge $480/tcm, which is much closer to the market rate, it’s selling gas to the EU at around $420/tcm.

So the numbers offered by Gazprom seem to be in line with the market, plus about 20% because you always start negotiations that way as the seller.

In any case, the EU has gotten agreement from both sides to act as an independent monitor of gas flows, because they want their gas:

After phone conversations with Prime Minister Vladimir Putin of Russia and his Ukrainian counterpart, Yulia Tymoshenko, on Wednesday, the European Commission president, José Manuel Barroso, said both leaders had agreed in principle to allow monitors to verify gas movements. But he also warned both countries — and particularly Ukraine — that failure to help restore supplies could have consequences for their relationships with the European Union.

(emphasis mine)

It turns out that the best guess here is that reductions of gas leaving the Ukraine side were far greater than the reductions that the Russians reported on their side, and the implication is that the Russians are actually telling the truth when they are saying that the Ukrainians are stealing gas from the pipeline.

Also Wednesday, Chancellor Angela Merkel of Germany spoke with Putin by phone, and in Moscow, Putin met with a former German chancellor, Gerhard Schröder, who now serves as chairman of the board of a Gazprom-controlled company planning to build a pipeline from Russia to Germany under the Baltic Sea, cutting out Ukraine.

(emphasis mine)

It appears that the Germans certainly think that the Ukraine is taking more than it buys from Russia, and I’m inclined to agree.

Much of recent Ukrainian economic expansion, before the world wide recession hit, was driven by below market gas supplied with the implied quid pro quo that Ukraine would be an ally of Russia, and having to pay fair market value for the gas is a real hardship, particularly now that FSU countries’ economies seem to be in free fall.

Like the chicken said, “You knew the job was dangerous when you took it.”

That being said, we are not seeing a punitive price, and best evidence is that the Ukrainians are stealing the gas.