Historically, Russia partially supplied Ukraine via natural gas offered as payment in-kind for transiting Russias gas onwards to Europe, and partially through annual sales contracts. In the past few years, Turkmenistan has become Ukraines largest source of natural gas imports through long-term contracts. In May 2001, Ukraine and Turkmenistan signed an agreement calling for Turkmenistan to supply Ukraine with 8.8 Tcf/year of natural gas between 2002 and 2006. Leaders of Turkmenistan and Ukraine pledged to increase levels to around 14 Tcf/year for 2007-2032.
Ukraine holds 1.1 Tcf of natural gas in storage, and in January 2006 Prime Minister Yekhanurov announced a plan to increase the capacity at existing storage facilities to 1.2 Tcf by 2009. The six major facilities are located in the provinces of Lvov, Kiev, and Chernigov.
Ukraine plays a significant role to world energy markets as an intermediary connecting Russia, the worlds largest natural gas producer, with growing European markets. Also, as gas exports from the Caspian to Europe and Russia grow, Ukraine serves as the largest market for this natural gas. Roughly 93 percent of Ukraines natural gas imports are re-exported to world markets. Preliminary estimates for 2005 show that approximately 3.9 Tcf of Russian natural gas transited Ukraine en route to Europe. This represented roughly 29 percent of OECD Europes natural gas imports and 78 percent of Russias natural gas exports. The Ukrainian natural gas company, Naftogaz Ukrainy, also re-exports some of its contracted gas to the rest of Europe. During the first half of 2005, the company re-exported 78 Bcf and aimed to exports 177 Bcf for the entire year.
Europes dependency on natural gas exports from Russia drew worldwide attention in January 2006 when a longstanding dispute over price and payment mechanisms in the in-kind agreements caused Gazprom to shut off gas supplies to Ukraine. Supplies to Europe were also affected. Even though Russia has used the threat of a cutoff to demand higher natural gas prices in recent years, this was the first time that a supply disruption affected flows to Europe. Eventually, Russias natural gas company agreed to a sell its natural gas to RosUkrEnergo, a Zurich-based trading company 50 percent-owned by Gazprom at the market price of $6.51/mcf ($230 per thousand cubic meters). RosUkrEnergy will acquire some of the natural gas from Kazakhstan and Turkmenistan.
On January 4, 2006, Ukraine signed a five-year agreement to buy 580 Bcf of natural gas from RosUkrEnergo at $2.69/mcf (comprised of less expensive natural gas from Central Asia). In 2005, Ukraine contracted to buy 812 Bcf at $1.41/mcf. In turn, Russia agreed to pay Ukraine natural gas transit fees of 7.3 cents per thousand cubic feet per 100 miles, a 47 percent price increase from 2005. The contracts are also subject to review each year and may be adjusted to new market prices.

There are a few problems with the Ukrainian-Russian natural gas agreement. First, Turkmenistan will need to provide 3.3 Tcf of natural gas exports during 2006 to Ukraine, Iran, Gazprom, and its domestic market. This is 50 percent more than its export level during 2005. Turkmenistans exports during 2005 were only 7.6 percent higher than the previous year. Also, the contracted quantities for Gazproms 1.1 Tcf are included in the 1.4 Tcf that Naftogaz Ukrainy has contracted to buy. In addition, half of the ownership of RosUkrEnergo remains undisclosed. The company will be responsible for the most complex part of the deal, which will involve the mixing of the natural gas volumes from different countries at various prices. Finally, the deal has solidified Russias commitment to a contract price with Ukraine that is below full market value. In addition to shielding needed market signals, the below-market-value prices are causing other countries such as Georgia and Moldova to question their contracts with Gazprom.
The agreement also does not address Ukraines high level of energy intensity or the countrys need for energy diversification. The contract leaves the countrys economy vulnerable to natural gas price increases. Natural gas accounted for 46 percent of the countrys primary energy consumption in 2004. The World Bank forecasts that if gas prices double for Ukraine from their 2005 levels, then the countrys GDP growth rate would fall to -1.8 percent this year from levels of 2.4 percent in 2005.

Ukraines aging natural gas infrastructure is of growing importance and concern both to European consumers and Russian producers. Some of the pipes in the Ukrainian network have been in operation for 20-30 years, and repairs are rarely carried out because of a lack of available funds. In addition to pipeline disrepair, full capacity utilization is a problem. Roughly 1.4 Tcf per year of spare capacity is available on the system. An additional 1 bcf/year could be added through rehabilitation and upgrades of the existing infrastructure.
In June 2002, heads of state from Ukraine, Russia, and Germany, agreed to develop an international consortium called the OOO (Russian abbreviation for a Limited Liability Company) International Consortium for the Management and Development of the Gas Transport Network to manage and upgrade Ukraines natural gas distribution infrastructure. In October 2002, Ukrainian and Russian state-owned oil and gas concerns, Naftogaz Ukrainy and Gazprom, signed preliminary agreements, and in January 2003, the new company was registered in Kiev, with each company holding 50 percent. The partners are still considering several proposals for the structure and membership of the Naftogaz Ukrainy/Gazprom consortium. Germanys Ruhrgas has been present at the consortiums negotiations, but its role remains unclear. Several other parties have shown interest in the consortium, including Gaz de France and the EBRD.Ukraine has also suggested inviting other Caspian Sea region producers Turkmenistan, Kazakhstan, and Azerbaijan to participate.

In February 2006, a Ukrainian-Russian joint-venture will begin construction of the first stage of a natural gas pipeline that will increase Ukraines transport levels to Western Europe. The joint venture was formed in 2004 between Naftogaz Ukrainy and Gazprom. The construction of the $2.2-$2.8 billion pipeline from Uzhorod to Novopskov on the border with Slovakia will be completed by 2009. Construction of the initial section of the pipeline was postponed from 2005 to February 2006 and will take approximately two years to complete. The completed pipeline will have a capacity of roughly 670 Bcf per year and will permit a 25 percent increase in the flow of Russian natural gas to Europe. Ukraine is guaranteeing a zero tax rate on gas flows through the pipeline until the joint venture receives a positive return on investment.
The joint venture also has plans to construct a new pipeline from Alexsandrov Gay on the Russian portion of the Central Asia Center system to Novopskov in eastern Ukraine. This will aid in the transit of Turkmen natural gas to Ukraine.