UKRAINE: AN UNSEEN IMBROGLIO?

David Marples and Myroslava Uniat

The administration of President Viktor Yanukovych and Prime Minister Mykola Azarov appears to be in confusion. On the one hand it faces a large bill from Russia’s Gazprom for portions of unused gas, along with intense pressure from the Russian government to join the Customs Union. On the other, it awaits a significant summit with the EU in Brussels on February 25 to discuss an Association Agreement, a prelude to its potential signing at the EU Eastern Partnership in November in Vilnius, without first meeting preconditions requested by the Europeans. In fact the president seems blandly oblivious of the tightrope he is walking, assuming that in the world of realpolitik, it is Ukraine rather than Brussels that holds most of the cards. The Ukrainian leader’s logic is that the Kyiv government can operate between the EU and Russia, which are also limited in their bargaining power: Russia, because it needs Ukraine to make the Union work, and the EU because by isolating Ukraine, it would push that country firmly into the Russian orbit. He has witnessed similar maneuvers by the president of Belarus, after all, who has survived largely unscathed to date and remained in power for almost two decades.

In reality, however, Ukraine’s position seems much weaker than the Yanukovych-Azarov team imagines or acknowledges. Russian pressure is constant. The former deputy of United Russia, Sergey Makarov, commented that if Ukraine joined the Russian-led Customs Union—it currently comprises Russia, Belarus, and Kazakhstan, and Kyrgyzstan has expressed a wish to join—then the $7.09 billion fine for unused gas will simply be waived. Joining would also mean more chances that gas prices would be reduced (http://www.pravda.com.ua/news/2013/02/8/6983116/). In brief: join us and your troubles are over! Understandably, the Ukrainian side baulks at Gazprom’s demand, partly because it has denounced the 2009 agreement, signed between former Prime Minister Yulia Tymoshenko and then Russian Prime Minister Vladimir Putin in 2009, which failed to anticipate the fall of gas prices and committed Ukraine to paying for the full amount of imported gas, whether or not it was actually needed. Deputy Prime Minister of Ukraine Yuri Boyko met with Chairman of the Gazprom Board Aleksey Miller in early February and stated that he did not think it appropriate for Ukraine to pay such a sum (http://www.pravda.com.ua/news/2013/02/8/6983148/).

Meanwhile, the Regions Party has not responded to a variety of requests from the Europeans to fulfill what are seen as essentially minimal requirements for the signing of the Association Agreement in November. The Dutch Ambassador to Ukraine, Pieter Jan Wolthers, has commented that there is no guarantee that the Association Agreement will be signed because all depends on the Ukrainian side meeting the terms, which include dealing with the issue of selective justice (http://www.pravda.com.ua/news/2013/02/9/6983182/). Likewise, Lithuanian president Dalia Grybauskaite, whose country takes over the presidency of the Council of the European Union in the second half of this year, informed Yanukovych during his working visit to Lithuania on February 6, that she believes the imprisonment of two former opposition leaders, Tymoshenko and former Interior Minister Yuri Lutsenko, to be politically motivated. She also took Yanukovych to task over the Customs Union, pointing out to him that the simultaneous signing of agreements with the EU and the Customs Union was impossible, because the two contradict each other (http://postup.brama.com/usual.php?what=75559). Therefore it is necessary for Ukraine to choose one or the other. British analyst Andrew Wilson posits that Yanukovych is ignorant of how the EU works, believing that the crucial matter is a balance of power and that the EU’s concern for Tymoshenko is ritualistic. Wilson’s view is that Yanukovych expects at some point that the EU will simply stop making demands and sign the Association Agreement, whereas in reality Ukraine is becoming isolated (http://zaxid.net/home/showSingleNews.do?u_yes_rozdratovani_nevikonanimi_obitsyankami_yanukovicha&objectId=1278035 accessed Feb 17).

For his part, Yanukovych is defending himself and casting stones simultaneously. First of all, he informed European Commissioner Stefan Fule on February 7, his Regions Party has already introduced draft proposals to meet some of the EU’s demands starting in 2010. They are somewhat delayed because he has to deal with officials and politicians “who are used to living in the old way” (http://www.pravda.com.ua/news/2013/02/8/6983134/). He responded to Grybauskaite that Ukraine could not ignore the fact that trade with the members of the Customs Union currently amounts to more than $60 billion, and therefore he supports “simultaneous cooperation” with the EU and the Customs Union. He also blamed the EU Energy Community, which Ukraine joined in 2010, for its failure to intervene to defend Ukraine when Russia made the demand for $7.09 billion for gas, a comment to which director of the Community Secretariat Janez Kopač responded with surprise, noting that Ukraine has to date never requested such assistance (http://zaxid.net/home/showSingleNews.do?u_yees_zdivovani_zakidami_yanukovicha_pro_vidsutnist_dopomogi&objectId=1277536).

Other officials simply blame the parliamentary opposition for the lack of progress on meeting EU requests. Thus Cabinet and Regions Party member Olena Lukash stated that five projects have been submitted to parliament, dealing with improvement in laws to combat corruption, and increasing penalties for corruption offenses. The president has submitted two bills dealing with the ratification of the UN protocol against the illicit manufacturing and trafficking of firearms. She hopes therefore that the opposition will provide its support for the adoption of European laws and confirm its choice of European integration (http://www.day.kiev.ua/uk/news/090213-v-uryadi-zapevnyayut-shcho-pracyuyut-na-ievrointegraciyu). The opposition in turn has blocked the parliamentary tribune in an effort to demand individual voting of each deputy (http://www.pravda.com.ua/news/2013/02/8/6983114/), ending the practice of multiple voting through the voting cards of absent MPs. On February 20, however, it supported the Parliament’s draft statement on implementing Ukraine’s goals for integration with Europe and signing of the Association Agreement.

The subplot behind these issues is the continuing detention of Tymoshenko and Lutsenko cited above, and the recent introduction of new criminal charges against the former for the murder of former parliamentary deputy Evhen Shcherban in 1996, together with the then Prime Minister Pavlo Lazarenko, who is still under house arrest in the United States serving a sentence for money laundering. One possibility widely discussed is that Yanukovych could conceivably pardon Lutsenko, a secondary figure who would be unlikely to pose a political challenge, if he received such a request. The former minister has been diagnosed with cirrhosis of the liver and portal hypertension, and political analyst Volodymyr Fesenko surmised that his release could happen prior to the EU-Ukraine summit on February 25. Lutsenko’s wife, however, thought that her husband would not request such a pardon, which would imply an acknowledgement of guilt (http://zaxid.net/home/showSingleNews.do?yanukovich_ukazom_mozhe_zvilniti_lutsenka__nardep&objectId=1277817). But without any such concessions, it seems inconceivable that the Europeans would be very welcoming toward the Ukrainian leaders in Brussels.

The irony of these complex discussions and internal wrangling is that even a leader as out of touch with the world around him as Yanukovych, and his trusted aide Azarov, would not have to do much to assuage the anger emanating from some capitals of Europe. The early release of Lutsenko, with or without a pardon, would cost the president nothing, but would be perceived as a positive step from the EU’s perspective. Moreover, the oligarchs within and outside the Regions Party have little to gain from Ukraine being drawn into the Customs Union, which would curtail their control over a lucrative part of the domestic economy as well as reducing Ukraine’s political independence. At times the president does appear to perceive where future policy should lie. All too often he appears simply to be unaware of the limitations of his position, which unfortunately affects not only to his administration, but the Ukrainian state, which has a limited number of options. Despite the growing authoritarianism and corruption of his government and in the country at large, Yanukovych has an opportunity to move closer to the EU. It is one that requires decisive and prompt action.

Moving West is ‘Lesser Evil’ for Ukraine

David Marples

On March 30, the EU and Ukraine initialed the text of a new agreement that includes a “deep and comprehensive free trade area.” Is Ukraine now moving irrevocably westward?

Of late, one finds many apocalyptic accounts about Ukraine: rampant corruption, likelihood of default on foreign loans, crackdowns on former leaders of the Orange administration such as Yulia Tymoshenko and Yuri Lutsenko, the manipulation of elections, and falling popularity for the ruling Regions Party and its president Viktor Yanukovych.

All these factors exist in part or fully, but the crucial question for Ukraine concerns foreign policy: does it move to the EU or become part of the Russian orbit? In the background to this debate is the key component of energy, and specifically payments for Russian gas and oil and whether Ukraine can come up with alternative strategies to its dependence on Moscow.

Evgeny Kurmashov, director of political programs at the Gorshenin Institute, surmises that in his third term Russia president Vladimir Putin will try to increase Russia’s political influence in neighboring states and integrate them into the Russian geopolitical sphere. The various means—the Customs Union, Eurasian Union, gas transit consortium, and CIS free trade zone—are all part of the same Kremlin puzzle.

Generally Ukrainian residents are reticent about a free trade agreement with Russia. A poll conducted among members of the parliament in March indicates that 45.4% of MPs oppose it, and only 21% support it without reservations. Analyst Yuri Matsiyevsky has observed that the reintegration of Ukraine into the post-Soviet space will block Ukraine’s move toward the EU. Yet Yanukovych continues to negotiate with the EU because, according to Matsiyevsky, the degree of antagonism toward it in eastern and southern regions is lower than the degree of rejection of cooperation with Russia in Western Ukraine. It is the “lesser evil” in other words.

Other reasons for a move to Brussels are evident. President Yanukovych and his government are seeking ways to avoid complying with the gas agreement signed by former Prime Minister Tymoshenko and Putin in early 2009 whereby Ukraine agreed to pay a base rate of $450 per thousand cubic meters, well above today’s world price. But the alternatives are problematic.

The exploration of shale gas in southern Ukraine is still being explored—it is prohibitively expensive to produce—but the most far-fetched scheme is one to re-export Russian gas from Germany to Ukraine through an agreement between Ukraine’s Naftohaz and the German company RWE, based in Essen.

Also, the attempt to replace Russian supplies of gas with those from Turkmenistan, following high-level talks between Ukraine and the Central Asian country, is premature. Until the completion of the Trans-Caspian pipeline, Turkmen gas can only reach Ukraine through Russia, thus supplies could be affected at any time.

Still, Ukraine is leaning toward the West, whatever the difficulties involved.

Its economic power structure essentially now comprises three main groups that have managed to prevent serious intrusions from Russian businessmen: these are influential Regions members Rinat Ahmetov and Borys Kolesnikov who control the metallurgy industry; the Rosukrenergo company, headed by Dmytro Firtash; and members of Yanukovych’s own family and friends, who are growing markedly in influence.

What these power bases have in common is a desire to trade with the EU and to avoid as far as possible economic takeovers by Russian oligarchs.

As for the Europeans, they have slowly brought Ukraine into the fold. In 2005, the EU and Ukraine signed a Memorandum of Understanding on Energy Cooperation that included an Action Plan. On 1 February 2011, Ukraine joined the Energy Community, and Ukraine has taken steps to improve the safety of its nuclear plants (especially in the wake of the Fukushima disaster), to integrate electricity and gas markets, and to improve safety and restructure the Ukrainian coal industry, which has been in decline since the 1980s.

Yet Ukraine is proving an awkward partner. The initialing of the association agreement was delayed because of the EU’s concern about the treatment of Tymoshenko. Ukraine, in short, has been behaving like Belarus, though thus far the EU has refrained from imposing sanctions.

Brussels is also concerned about the astounding scale of corruption in Ukraine, which has darkened a once promising economic outlook. Essentially the government is appeasing the population with higher wages and pensions while depleting foreign currency reserves and coming up with wild solutions to pay off enormous debts—around $15 billion to Russian and European banks, as well as the IMF—and to keep its domestic currency afloat.

A recent report from Kyiv by Zenon Zawada notes Prime Minister Mykola Azarov’s announcement on March 12 that he intended to pay back debt to the IMF by requesting another loan from the same agency—a comment later retracted, but revealing nevertheless of the far-fetched economic policies.

In these circumstances, the EU partner grows increasingly frustrated and the Russian side more hopeful; while the oligarchic clans are preoccupied with their internal struggle, a classic case of fiddling while Rome—in this case Kyiv—burns.

This article was first published in the Edmonton Journal, 31 March 2012.

UKRAINE’S GAS PROBLEMS AND HOW TO RESOLVE THEM

David Marples

Ukraine continues to discuss prices for gas and the volume that should be purchased from Russia, which in turn, through the state-run Gazprom, makes demands on its neighbor, while threatening to divert more supplies to its Nord Stream line, with the prospect of the South Stream starting up in the near future. The impasse poses a serious energy dilemma for the Ukrainian government, which imported up to 70% of its gas and 65% of its oil requirements in 2011. Ukraine is by far the biggest consumer of gas in the central European region, but it has been unable to resolve a problem that started with independence and reached an acute level in 2006 and 2009 (see, for example, Jonathan Stern, “Natural Gas Security Problems in Europe: the Russian-Ukrainian Crisis of 2006,” Asia Pacific Review, Vol. 13, No. 1 (2006): 32-59) .

There are a number of issues at stake. First, there is the economic and political relationship between Ukraine and Russia. The latter country is adamant that Ukraine should join its Eurasian Economic Community and that in order for the price of gas to be lowered, it must make some concessions, such as the sale to Russia of Naftohaz, Ukraine’s national oil and gas company. For its part, the Yanukovych administration has a dual complaint: Ukraine agreed to pay $388 per thousand cubic meters of gas (tcm) under the agreement made by former Prime Minister Yulia Tymoshenko in 2009, but this level is extraordinarily high for a neighboring state; and it also wishes to reduce obligatory gas imports from Russia to 27 billion cubic meters (bcm) from the 52 bcm stipulated in the contract (RIA Novosti, Feb 1).

Second, Russia has put pressure on Ukraine in other areas too. In early February it instigated a so-called “cheese war,” by prohibiting imports of cheese produced in Ukraine. According to one account, there was more at stake than dairy products—Russia began a similar dispute with Belarus in the summer of 2009 after that country declined to privatize its dairy industry—and the dispute was linked to Russian territorial claims on Crimea. It cites a statement by Stanislav Govorukhin, a Duma deputy who is the head of Vladimir Putin’s electoral headquarters, reportedly commented that Crimea and Sevastopol should be returned to Russia by means of the economic integration of Ukraine with its neighbor, as well as into its religious and cultural-historical space (Glavred, Feb 13, at: http://glavred.info/archive/2012/02/14/161348-2.html).

Govorukhin’s needlessly provocative statement may have been a means to divert attention from the anti-Putin protests taking place prior to the March 2012 presidential elections in Russia. But they nonetheless put further pressure on Ukraine. The same applies to the construction of Nord Stream, which was officially launched in early November last year, and should account for the transport of about one-sixth of Russian gas exports in 2012 through a pipeline from Vyborg, near St. Petersburg, under the Baltic Sea, to Greifswald in eastern Germany. The anticipated capacity of the pipeline, which may be attained by 2015, is 55 bcm, and would allow Russia to transport about one-third of its gas to the countries of the European Union for the next fifty years (Nord-stream.com, Nov 8, 2011). South Stream, a pipeline that is planned between Russia’s Black Sea coast from the Pochinki compressor station south of Novorossiysk to the Romanian coast just north of Varna is anticipated to start construction in 2012 and to be transporting gas by 2015 (http://south-stream.info/index.php?id=10&L=1).

Ukraine’s energy situation was discussed recently at a round-table of the Kyiv-based Gorshenin Institute under the title “Is Gazprom monopolizing the European gas market?” Anatoly Kinakh, former Prime Minister and Minister of the Economy of Ukraine, and the head of the Party of Industrialists and Entrepreneurs, began somewhat predictably by attacking the 2009 agreement by Tymoshenko, and maintained that the contract needs to be renegotiated with Russia without confrontation because the latter country is Ukraine’s “strategic partner.” He perceived the need to balance the interests of suppliers (Russia and Central Asia), the transit region (Ukraine), and the consumers (countries of the European Union). Ukraine also in his view needs to improve its energy policy by developing energy-saving technology and increasing the consumption of domestic energy resources (Levyi Bereg, Feb 7, and ff., at: http://economics.lb.ua/trades/2012/02/07/135340_gazprom_monopoliziruet.html).

Ivan Plachkov, former Minister of Fuel and Energy, and a board trustee member of Kyivenergo, is much in agreement with Kinakh, and he asks how Ukraine might lower its dependence on Gazprom. First, he believes, Ukraine can reduce its consumption, which is 4-5 times more gas per unit of GDP than the average in Europe. The situation would stabilize if Ukraine could cut consumption by 50%. He suggests also reforming Naftohaz, and allowing more gas traders access to the Ukrainian market. There should also be more exploration of shale gas in the Black Sea region as well as reliance on existing energy resources of coal, oil, and nuclear power. His comments, however, raise the issue of whether Ukraine would be permitted to reduce the amount of gas it purchases from Gazprom. Another speaker, Volodymyr Saprykin, who is Director of Energy Programs as the Razumkov Center, notes that the Kharkiv Accords, while not a favorable agreement, at least allowed for a reduction of $100 in the price of gas and elimination of penalties for not purchasing the minimum volume. He also advocates increasing the strategic reserves of oil and gas.

One speaker in the round-table was more sanguine about the prospect of developing domestic resources of gas. Yurii Korol’chuk of the Institute of Energy Research maintains it is impractical to produce shale gas, construct a liquefied natural gas terminal, or carry out explorations of the Black Sea littoral because Ukraine lacks money for such projects. Preferable in his opinion is to raise energy efficiency. Valery Borovyk of the “New Energy of Ukraine” alliance thinks that the issue is not only the fact that Gazprom can influence European officials, but also that it has clout among Ukrainian officials, especially those in the energy sector and government, who have no interest in lowering domestic gas consumption. However, people should not be alarmed by the construction of the Nord Stream and the South Stream (carrying Russian gas under the Black Sea to Romania and thence to other European countries). He believes that Nord Stream can divert a maximum of 15% of gas supplies from Ukraine, whereas the South Stream project is likely to collapse because gas consumption worldwide will fall in the wake of the economic crisis.

Are there any other alternatives for Ukraine? One analyst notes that the year 2011 was important for keeping the country on course for integration into European structures. Ukraine also joined the European Energy Committee and made progress on the issue of liberalizing the EU visa regime. But despite such progress and what she describes as “titanic efforts of several ministries,” the goal of integration is more distant than it was at the start of 2011. Western leaders are very concerned about the increasing authoritarianism in Ukraine, the imprisonment and ill treatment of Tymoshenko, and President Viktor Yanukovych’s defiant refusal to take seriously the criticisms of his European counterparts. As a result Ukraine has frittered its first year in the Energy Community, and the dialogue on visa issues has stalled and will not be resolved by the time Euro-2012 begins in June. Perhaps most significantly, Ukraine is strategically dependent on Russia, a country that has long forgotten Kyiv’s past concessions made against its national interests, as demonstrated by the “cheese war.” Yet there are few alternative openings: the United States is losing interest in Ukraine and few practical steps have been taken toward deepening relations with China. In Silina’s view, Ukraine does not have a foreign policy doctrine (Tatyana Silina, Zerkalo Nedeli, Feb 10, at: http://zn.ua/POLITICS/my_sami_zakryli_vorota,_my_sami-97143.html).

Her article raises another key question: that of Ukraine’s failure, vis-à-vis Russia, to gain more publicity for its part in past gas wars. Part of the problem is the close relationship between Gazprom and local companies and influential statespersons in the EU, particularly in Germany and France. The Europeans prioritize gas supplies over regional squabbles, and in such situations tend to side with the supplier rather than the country providing the conduit. They are also in favor of the development of alternative paths such as Nord Stream and South Stream that will cut into Ukraine’s role as the dominant pipeline provider. Thus Ukraine needs not only to build up its domestic resources, but also to cut back significantly on the amount of energy it uses. Added to that, the Yanukovych leadership needs to boost its public image, and could make a significant start by releasing political opponents such as Tymoshenko and former Minister of Interior Yurii Lutsenko. To add to its embarrassment, the European Court of Human Rights is likely to announce its decision on the Tymoshenko case on the eve of or during the forthcoming parliamentary election campaign (Glavcom.ua, Feb 13, at http://glavcom.ua/vblog/2471.html).

There is little indication, however, that such steps will be taken or even that they are being considered. Morally, and in terms of human rights, there is little to distinguish between the current leaderships of Ukraine and Russia and accordingly neither Brussels nor Washington are likely to endanger their relationship with Moscow by offering strong support for Ukraine’s position in its energy battles with Russia. The problems are not new. They were evident as soon as Ukraine began its independent existence in late 1991, as illustrated by the problems faced by its first president Leonid Kravchuk. That they remain even more acute twenty years later is a sad reflection of the failure of all the administrations to date to devise a viable energy policy, let alone a solution to dependence on Russia. It signifies that Ukraine enters every discussion as the weaker partner in what is essentially a power struggle on several levels and with few clear rules.

IS UKRAINE LEAVING THE EUROPEAN ENERGY COMMUNITY?

David Marples

As Ukraine’s relationship with the EU continues to flounder over human rights issues, the imprisonment of former Prime Minister Yulia Tymoshenko and the lengthy detention of former Interior Minister Yuri Lutsenko, there are signs that the government is prepared to flout existing laws to gain closer association with Gazprom and the Customs Union of Russia, Belarus, and Kazakhstan. The consequences could be not only the loss of links with the European Energy Community (hereafter EEC) but also the undermining of sovereignty.

On December 4, Russia’s Ambassador to Ukraine Mikhail Zurabov announced that the new gas agreement between the two states would have the status of an international agreement, rather than a business arrangement between the two responsible companies, Gazprom and Naftohaz. Russia is evidently responding to the EU’s plans for closer integration with Ukraine and greater transparency in the transit of gas from Russia to Western Europe. Analyst Maksim Alinov comments that the results of the inter-state agreement proposed by the Russian ambassador would override current Ukrainian laws, which make it illegal to transfer Ukraine’s transit system to Russian control—a similar sale to Gazprom occurred recently in Belarus. Alinov also believes that the flouting of the agreement in place would also give Russia significant influence over the internal economic and political situation in Ukraine (Zerkalo Nedeli, Dec 9).

Another analyst, Maksim Honchar, goes further, maintaining that Kyiv’s apparent reversal of policy on the EEC would violate the July 1, 2010 law “Concerning the main principles of domestic and foreign policy,” Article 7 of which stipulates that Ukraine’s oil, gas, and electricity networks should be operating according to EU rules. In his view this indicates a willingness to surrender national interests, which would be an even more serious threat to Ukraine’s pro-European policy than the imprisonment of Tymoshenko. It would also strengthen considerably the position of Gazprom, a monopolist enterprise that seeks to deploy energy as an instrument of political control. Ukraine would acquire cheap gas but gradually lose its sovereignty, rendering the Association Agreement with the EU obsolete and leading to the next stage, which would be a defensive alliance with Russia (Zerkalo Nedeli, Dec 9).

The EU meanwhile continues to demand the release of Tymoshenko as a prequel to the initializing of the Association Agreement, though with diminishing hopes and growing frustration. Wilfred Martens, President of the European People’s Party, stated that Ukraine, like Poland, could be an important EU player, and that without its addition the EU project could not be complete. However, as a prerequisite to the start of the process leading to the Agreement, the Party of Regions must release Tymoshenko, Lutsenko, and other political prisoners (UN IAN, Dec 7). However, Foreign Minister Kostyantyn Hryshchenko demurred, stating that Tymoshenko could not be used as a bargaining chip in trade relations and that her situation was a matter for the Ukrainian Judiciary. To discuss the issue in this way, he added, would be tantamount to indicating that the latter is not an independent body (UNIAN, Dec 7).

Although the ruling group of Ukraine faces several serious economic dilemmas and recently rejected for a second time the IMF’s demand to raise energy prices, it does not seem to be facing a serious threat from the opposition. Indeed, the political situation seems relatively unaffected by the Tymoshenko saga. Analyst Kost Bondarenko maintains that the population has lost interest in the struggle between Tymoshenko and the ruling elite, while Vadim Karasev considers that the apparent lack of public sympathy for Tymoshenko reflects the general perception of her as a former representative of the political establishment (Segodnya, Dec 7, and ff.). In general therefore that is a positive sign for the authorities and a signal that the arrest of Tymoshenko has not affected ratings for the president and the Regions Party.

The latter seems to be calculating each step in cynical fashion, taking action and then monitoring the response. Karasev also notes that the leadership thinks the release of Tymoshenko would be seen as a sign of weakness. Also the Ukrainian leaders are watching closely political events in Russia, where the rise of oppositional activities could have a domino effect in Ukraine. Various polls denote that Yanukovych remains the leading individual politician with ratings between 17.4 and 20.7%, whereas the ratings of Tymoshenko, the only serious contender, range from 13 to 14.1% (polls by KMIS, Social Monitoring, “Rating,” and Sotsis). Yatsenyuk in third place has, at most, 9.9% support. In short, there is no longer a serious contender from the opposition as with Tymoshenko out of the picture.

The ruling group may also consider that in the year 2011 it could have expected to see its popularity drop because of the introduction of unpopular measures such as pension and taxation codes, whereas the new year may bring better fortunes, not least through the hosting of the popular soccer competition, Euro-2012. Perhaps of more importance is the evident tolerance of the EU for the abuses of power in Kyiv, in contrast to the sanctions it has applied in Belarus. Ukraine has moved rapidly from one of the most democratic of post-Soviet states to a position well down the scale. At the same time the corruption that has long pervaded the Ukrainian economy has not diminished.

Adding to the contentedness of the ruling group in Ukraine, the United States is preoccupied with other issues and unlikely to engage with Ukraine at the highest level until after the 2012 presidential election, according to former US ambassador to Ukraine, Steven Pifer (http://www.brookings.edu/reports/2011/1208_ukraine_pifer.aspx?p=1). Thus Yanukovych and the Regions have in effect carte blanche to continue the current path. The EEC agreement appears to have been jettisoned.

However, for the second time since the January 2010 election (the first being the Kharkiv Accords on the Black Sea Fleet), they are posing serious threats to the sovereignty of Ukraine, relinquishing hard-won rights for the immediate prospect of cheap gas and permitting a much more powerful role for Russian agencies like Gazprom to step in and purchase Naftohaz. The next logical stage would be for Ukraine to join the Customs Union (with Russia, Kazakhstan, and Belarus). Only a year ago that would have been unthinkable, but it is now a serious possibility.

Yanukovych’s Motives Murky

David Marples

The news that imprisoned former Premier of Ukraine Yulia Tymoshenko is now facing charges of embezzlement, linked to her time as the president of United Energy Systems of Ukraine in the 1990s, raises questions about the motivations of the Ukrainian government and President Viktor Yanukovych in particular.

Why was she jailed in the first place? And why has an old issue, linked to a time when virtually all the Ukrainian oligarchs had their hands in the public trough, suddenly resurfaced?

On October 10, Tymoshenko received a 7-year prison sentence for her part in a gas deal negotiated with Russian Prime Minister Vladimir Putin in 2009 that was “disadvantageous for Ukraine.” Throughout the trial she had expressed her contempt for the judge and prosecutor and argued that the procedure was politically motivated. Virtually all the Western governments concurred while Russia was furious that the 2009 agreement had been so publicly reopened.

Yanukovych, supposedly, wished to rid himself of his main political opponent before the parliamentary elections scheduled for October 2012. However, the trial and verdict endangered Ukraine’s chances of signing an Association Agreement with the European Union, which has been under negotiation for some time. Some critics, such as David Kramer of Freedom House, maintain that the discussions should be postponed until Tymoshenko and other opposition leaders have been released and pardoned.

But why was she tried and imprisoned at all?

One suggestion, offered by Dominique Arel, Chair of Ukrainian Studies at the University of Ottawa, is that Yanukovych persecuted Tymoshenko because he believed he could get away with it. The premise is that for the Europeans, relations with Ukraine are too important to be imperiled by a domestic quarrel.

Writing in a Russian source, analysts Maksim Logvinov and Vladislav Zhukovsky, think that the goal of the original trial was to force Russia to revise the price of gas sold to Ukraine. They also maintain that targeting Tymoshenko was a means to divert blame from the government for the economic crisis that Ukraine will face shortly because of the high prices of gas. However, the gamble failed because all the relevant parties—Russia, the EU, and the United States—took the side of Tymoshenko and criticized the Ukrainian authorities. In many ways the trial became a cause célèbre for the embattled Ukrainian opposition.

Yet the actions of Yanukovych still lack rationale and these analyses perhaps attribute a degree of Machiavellianism and political astuteness to the president that have not always been evident, despite his triumphant election victory in January 2010.

Ukrainian analyst Vitalii Portnikov has provided the most logical explanation: the initiatives in the Tymoshenko case are not coming from the president but from a “party of war” within the leadership that includes the head of the Secret Service (SBU), Valery Khoroshkovsky, Serhii Yevochkin of the presidential administration, the Energy Minister Yury Boyko, prominent businessman Dmytro Firtash, and Minister of Foreign Affairs Kostyantyn Hryshchenko. Their goal is to isolate Yanukovych and undermine any plans for integration with the EU or the Russian-led Customs Union. Both are perceived as threats to their own power.

The presence within this group of Firtash is possibly the most significant. An ally of former president Viktor Yushchenko, he established a position for his company RosUkrEnergo as an intermediary in the bitter gas war between Russia and Ukraine. Firtash offered to buy the gas from Russia and resell it to Ukraine.

Tymoshenko, a woman of formidable business acumen, cut Firtash out of the equation with the 2009 agreement. He is now officially back in business (he also controls much of Ukraine’s titanium industry), and out for revenge. The goal appears to be to ensure the complete demise of his rival.

As for the new charges, there is little question that Tymoshenko—then known as the “gas princess”—benefited from state patronage. From 1995 to 1997, when she was president of United Energy Systems of Ukraine, she was given highly lucrative government contracts—including control over imported gas from Russia—by then Prime Minister Pavlo Lazarenko, who was later convicted for money laundering and wire fraud by a US court. Yet the list of those who could be tried for past crimes in Ukraine is a long one that includes many current oligarchs, and one past president.

It seems safest to assume that either Yanukovych is far more scheming than many have surmised hitherto, or else (and more likely) he is being prodded and pushed by powerful interest groups whose goal is to keep Ukraine free from economic ties so that they are left free to amass wealth.

Such “freedom” requires the obliteration of the opposition and its leader, manipulation of elections, and systematic deployment of the SBU against their critics. In Arel’s view, by targeting Yulia Tymoshenko the Ukrainian government has demonstrated it has the wherewithal to stop opponents from challenging the president. The main casualty is democratic Ukraine.

But few of the “party of war” are likely to lose sleep over that.

This article first appeared in the EDMONTON JOURNAL, 15 October 2011

RUSSIA AND UKRAINE: A NEW STAGE IN THE GAS WAR

David Marples

Introduction

The public furor over the trial of former Prime Minister Yulia Tymoshenko has tended to overshadow another critical issue, namely that of gas and energy relations between Ukraine and Russia. Indeed in many respects it is a question that Ukrainian leaders have been obliged to address since the start of independence twenty years ago. Europeans are justifiably nervous about the prospect of another gas war between Russia and Ukraine. Each side accuses the other: the Russians maintain that Ukraine’ behavior has been duplicitous and childish; the Ukrainians complain that they are paying prices for gas that are far higher than those for some European consumers, such as Germany and Italy, thanks to the gas deal negotiated between Tymoshenko and Russian Prime Minister Vladimir Putin in 2009.

At issue are the following. Rather than signing an agreement to join the Russian-led Customs Union, and following the stipulations of the 2009 agreement that Ukraine has to buy a minimum of 33 billion cubic meters of gas annually and will be paying $400 per cubic meter by the end of 2011, Ukraine has threatened to seek arbitration from an international court in Stockholm, purchase gas from Turkmenistan or Azerbaijan, cut down gas consumption, and find more domestic sources that could alleviate the situation. Its pursuit of associate membership of the EU continues, although it is threatened by the publicity surrounding the trial of Tymoshenko, which is unacceptable to many Europeans and appears contrived. Russia in turn has opposed the trial, not because of affection or support for the former Prime Minister, but because the outcome could conceivably affect gas relations with Ukraine. If the 2009 deal is found to be illegal (thereby confirming the “guilt” of Tymoshenko), then it could be abrogated and negotiations on gas prices would need to begin anew.

Russian Perspectives

In early September, a weekly experts panel on Russia Profile discussed the situation from Russia’s perspective, while taking into account some of the more recent maneuvers by the respective governments: thus for Russia the goals have been closer integration, to be attained by Ukraine joining the Customs Union or by the merger of Ukraine’s Naftohaz with Russia’s Gazprom, or by Ukraine allowing the latter control of the gas pipeline to Europe or its gas storage enterprises. If such moves were accepted, it is implied, then Ukraine would be in a better position to negotiate the price it pays for Russian gas. The situation is complicated, as pointed out by Vlad Ivanenko, by the fact that Russia also continues to improve its connections with EU countries, most notably Germany, thus nullifying the benefits of Ukraine’s forthcoming Association Agreement with the EU (Russia Profile, Sept 9).

Alexandre Strokanov, Director of the Institute of Russian Language, History, and Culture at Lyndon State College in Vermont, sees the situation as follows: the CIS is basically defunct, but most “Russian, Belarusian and Ukrainian people” are in favor of closer integration. He sees such integration as beneficial for all, and regards the Ukrainian position of promoting both EU membership and closer ties with Russia as contradictory. Russia’s position in his view is “much more clear and understandable” and is based on the 2009 agreement, and, in short, a contract is a contract and cannot simply be ignored with demands to lower prices. Vladimir Belaeff of the Global Society Institute in San Francisco argues on similar grounds that Russia has been a good neighbor, bestowing largesse on Ukraine in the expectation of friendly relations in return. But Ukraine has not reciprocated (Russia Profile, Sept 9).

Lastly James Jatras, Deputy Director of the American Institute in Kyiv, complains that Ukraine is relaying on “legal gimmicks” to change the current situation: “The prospect of Ukraine obtaining the lower gas prices it so desperately needs to revitalize its economy would greatly improve if Kiev would negotiate seriously with Moscow.” The logical way to do this would be for Ukraine to join the Customs Union that Russia has formed with Kazakhstan and Belarus, after which it could receive the same prices for gas as the Russian Federation. Alternatively by agreeing to a merger between Naftohaz and Gazprom, it would also be possible for the Ukrainian government to acquire the best possible price for gas (Russia Profile, Sept 9). Underlying all these comments—as some interviewees acknowledge—is the simple equation that Russia is going to sell the gas and the Europeans, especially the Germans, intend to buy. Hence if a new gas war should break out, Russia has the option of switching to the Nordstream gas line (and later the South Stream line) and cutting Ukraine out of the equation altogether. Hence if Ukraine does not bargain in good faith, it could conceivably lose its supply of gas.

The experts’ panel also rejects as a pipe dream Ukraine’s alternative sources of gas, such as the shale experiments in the Donbas region. At best this would be a long-term phenomenon, and it cannot affect the current situation, i.e. that Ukraine is dependent on its Russian neighbor. Support for integration, however, even in Belarus, has fallen constantly since independence 20 years ago. There is no indication that residents of Ukraine would support membership of either the Customs Union or the Collective Security Treaty Organization (CSTO), despite improved relations with Russia being one of the original platforms of Yanukovych in the 2010 presidential elections. In fact, Yanukovych has stated recently Ukraine will not pay heed to ultimatums from Moscow that are “inappropriate and humiliating for us” (Krymskaya Pravda, Sept 6). From the viewpoint of Kyiv, what is occurring is a form of neocolonialism, by which Russia makes demands and Ukraine is expected to follow. That is one reason why Ukraine is trying to find ways to extricate itself from an agreement it made two years ago; one that seemed reasonable at the time, but now appears unfavorable.

Ukrainian Perspectives

Ukrainian views are some distance away from those of the experts’ panel, which it should be added, are probably more moderate than some of the statespersons in Russia, not excluding President Dmitry Medvedev. Yuliya Mostova sees the Russian position, sardonically, as “Either we get everything, or you get nothing.” However, she believes that Yanukovych considers an agreement with Russia still possible for several reasons. First, the South Stream pipeline remains in the air because of opposition from Turkey, the key player in the Black Sea region. Second, revisions of agreements signed with Gazprom are hardly new, and have been explored by several European states hitherto. Terms are thus negotiable. Third, Turkmenistan is dissatisfied with its current relationship with Gazprom, and Yanukovych’s visit to Ashgabat on September 12-13 is a signal that the Turkmens are willing to discuss the issue. Tymoshenko’s nemesis, Dmytro Firtash, she anticipates, will play an important role in these negotiations with his company RosUkrEnergo. Fourth, by starting what she terms a “cold war” with Yanukovych, the Russians appear inconsistent in the eyes of their own public, since for years, the Ukrainian leader has been portrayed as a close friend of the Russian people. Lastly, it could be possible for Russians to purchase shares in Naftohaz without taking over the entire company. The latter scenario would signify a loss of sovereignty for Ukraine (Zerkalo Nedeli, Sept 2).

The legal aspects of the dispute were made more complex by the announcement on September 2 by Ukrainian Prime Minister Nikolay Azarov that Ukraine intends to break up Naftohaz into smaller units (Interfax, Sept 2). In Ukraine’s view, this would render null and void existing agreements with Russia. Moscow disagrees, and Gazprom’s Sergey Kupriyanov commented that any reorganization obligates the continuation of contractual rights, which must be passed over to the successor units. The Russian side believes that its position rests on solid legal grounds, and thus, as stated by President Medvedev, if Ukraine wants a discount on gas prices, then it should consider membership of the Customs Union. Naftohaz head, Oleh Dubyna, maintains that in 2009, Tymoshenko misled him when she claimed that the Ukrainian government had authorized the signing of the gas contract with Russia. This was denied in court by former president Viktor Yushchenko, who testified against Tymoshenko, his former ally in the 2004 Orange Revolution (Nikolay Zakrevskiy, “Ukrainu utomil gazovyi mezal’yans,” Obozrevatel’, Sept 5).

Undoubtedly, the Yanukovych administration is struggling to come up with a solution to its energy problems. The trial of Tymoshenko is an extreme manifestation of its dilemma and arguably one that has badly backfired. On the other hand, negotiating with Russia is problematic as new forms of pressure are being constantly applied. These are both direct and in more subtle forms. On September 8, the Moscow City Duma annulled its funding of the Black Sea Fleet in the 2011 budget year, a total of R70.6 million ($2.3 million), generally used for repairing barracks and schools for children of sailors (Krymskaya Pravda, Sept 8). More ominously, Aleksey Urin, advisor to the Embassy of Russia in Ukraine, stated that Russia would consider annulling the Kharkiv Accords (which extended the Russian Black Sea Fleet bases in Sevastopol until 2042) if Ukraine challenged the existing gas contracts in court (http://rus.newsru.ua/ukraine/07sep2011/ooreen.html). Another alternative, outlined by analyst Vitaliy Portnikov, would be for Russia to agree to annul the Kharkiv Accords, limit the sojourn of the Black Sea Fleet to 2017, and then negotiate a new agreement with Yanukovych’s successor as president in due course (http://rus.newsru.ua/columnists/08Sep2011/kharkov.html)–one implication here is that Russian withdrawal of support for Yanukovych would help to ensure his demise.

Conclusion

Despite the adamant Russian view that existing contracts are unchangeable, neither side can claim that laws are static in contemporary Russia and Ukraine. Both sides have amended constitutions, renegotiated existing agreements, and made contradictory statements. In this case the difficulty is clear: Russia is the provider of the resources and Ukraine the purchaser. Ukraine needs Russian gas, as do the Europeans, and yet its maneuvers suggest certain ambivalence as to its priorities and future directions. Like his predecessors Leonid Kravchuk and Leonid Kuchma, Yanukovych has opted for a so-called “multi-vectored” foreign policy, which only works if there are no decisive steps taken in one direction or the other. The Russian side recognizes, however, the innate incongruence in EU policy, i.e. that although Ukraine may be accepted into some form of associate membership, individual countries will trade directly with Russia, and bilateral relations—such as that between Russia and Germany—may take precedence, thus undermining the significance of a choice for Ukraine between West and East.

Secondly, the EU and Russia, for diverse reasons, are likely to condemn a guilty verdict in the Tymoshenko trial. The EU perceives the proceedings as a show trial, one conducted to remove the leader of the opposition from the political scene prior to the 2012 parliamentary elections. Russia is concerned that her conviction could nullify the trade agreement of 2009, as well as the proposed merger of Gazprom and Naftohaz, and lead to a reduction of the amount of gas that Ukraine purchases annually. Thus the trial will cast a shadow over the Yanukovych presidency internationally and reduce the credibility of his administration at a time when Ukraine is preparing to host the Euro-2012 soccer competition next summer.

Thirdly, the arguments of the Russian experts cited above notwithstanding, the relationship with Russia has proved difficult for several of its neighbors, not just Ukraine. Belarus has had similar problems over gas prices, and the result has been the forthcoming takeover of its gas transit company Beltransgaz by Gazprom, even though the initial agreement was for 50% ownership by 2011 (RIA Novosti, Aug 17). These are not negotiations in the normal sense of the word: meetings and discussions are followed by insinuations and warnings, including the annulment of the Kharkiv Accords, and the ultimate threat of cutting off gas supplies altogether. Admittedly, the position of Ukraine has been inconsistent and the decision to dismantle Naftohaz is a crude and obvious subterfuge. But it is also a sign of desperation.

Fourthly, for many years it has been unclear to many observers how Gazprom decides the prices for gas and who pays what price. Today, Ukraine pays more than Germany for Russian gas; and Belarus pays less (though the price is rising). What is the logic behind price setting? Why is it not dependent on market relations so that there is one price for consumers within Russia and one for foreign purchasers? Negotiations with Gazprom, further, seem to be concluded with takeovers of key transit companies or the gas enterprises of neighboring states. And since Gazprom is no longer a private enterprise but an arm of the Russian government, then it is difficult to dispute the fact that a Gazprom-controlled factory is in essence a Russian one, thus rendering the rhetoric of “merger” misleading. A merger signifies integration in an entity that can be perceived as the successor to the CIS.

All these issues were inherited by the Yanukovych regime, and like his predecessors he has applied clumsy and often incoherent policies. For any Ukrainian government, but especially one operating in the current harsh economic climate, the problem of self-sufficiency in energy is paramount. But there are no obvious solutions, either in new gas and oil exploration or in the further development of nuclear power—all Ukraine’s existing nuclear plants are of Russian design—as the latter would require two decades to take effect. That being said, it is hard to avoid the impression of the current Ukrainian administration as somewhat analogous in its methods to that of Medvedev and Putin’s Russia, of an increasingly authoritarian regime that is nonetheless anxious to appease its potential European allies, while imposing order within and undermining the painstakingly constructed democratic structure.

Perhaps that is why Yanukovych and his associates continue to believe that a new agreement can be reached with Russia. The two regimes currently in place in the respective countries have much in common. Unfortunately, the Ukrainian side has limited options, and few bargaining chips that can be used for negotiation and its targeting of Tymoshenko has alienated its main potential allies in Europe. Unfortunately, the end result may be not only the downfall of an unlamented leadership but the “return” of Ukraine to the Russian sphere of interest, one that is guided not be egalitarianism and equal partnership, but economic and political goals that are perceived as in the “common” rather than national interest. That is the stark reality facing the Ukrainian government today.

Gas Fuels Ukraine’s Political Strife

David Marples

Former Ukrainian prime minister Yulia Tymoshenko is on trial in Kyiv for negotiating a gas deal with Russia two years ago that was allegedly unfavorable to Ukraine. Last week she was hauled off to jail for her behavior in the courtroom, which included refusing to stand when the judge entered the room and verbally abusing some of the witnesses, including current prime minister Nikolai Azarov for speaking in Russian.

International opinion has condemned the administration of President Viktor Yanukovych for what appears to be a politically based trial. One analyst commented that with this trial the Ukrainian government has “crossed the Rubicon” in its slide from democracy to authoritarianism.

These issues are less clear-cut than they seem.

On the face of it the charges are far-fetched. Tymoshenko negotiated a deal as head of the Ukrainian government. Moreover, it ended an impasse with Russia that had led to cutoffs of gas supplies to several European countries in successive winters. However, the background is considerably more complicated.

Several issues are involved: conditions for the sale of gas; the price of gas; the nature of the relationship between Russia and Ukraine; and the bitter personal rivalry between the president of Ukraine and the leader of the opposition.

The essence of the 2008-09 talks between Russia’s Gazprom and Ukraine’s Naftohaz was to eliminate the middleman, in the shape of Dmytro Firtash, who reaped a fortune through his company RosUkrEnergo, which had acquired the right under former president Viktor Yushchenko to purchase gas from Russia and resell it to Ukraine. Tymoshenko justifiably considered such an intermediary superfluous and even dangerous.

At the beginning of 2009, the Ukrainian delegation walked out of the talks on the demand of Yushchenko. However, Tymoshenko then led a personal mission and a contract was signed on Jan. 19. But once she lost her position as prime minister, Firtash was reinstalled, ironically under Yushchenko’s former 2004 rival and new president, Yanukovych.

By the agreement of Jan. 19, Russia and Ukraine established a fixed price of gas until 2020 of $450 per thousand cubic meters. At the time the price seemed accurate. Today it seems inflated and shackling. It is much higher than the price at which Russia sells gas to other countries of Europe, for example.

In April 2010, Yanukovych met with Russian President Dmitry Medvedev to discuss the deal. The revised version linked the sale of gas to prolonging the stay of the Russian Black Sea Fleet in Sevastopol. It lowered the price below the world level, but Russia has consistently requested further talks on the issue.

Herein lies another issue, namely the relationship between Russia and Ukraine. Yanukovych is often accused of selling out Ukraine’s interests to Russia. In fact, he is clinging onto Naftohaz for dear life, while the Russians are constantly demanding its merger with Gazprom. The Tymoshenko deal is often the Russians’ starting point for new discussions.

In late July, Russia cancelled plans for Medvedev to attend a naval parade in Sevastopol after the Ukrainian government rejected another proposal to merge the two gas companies. However, Moscow has since explored another avenue, namely revisiting the issue of the Russian-Ukrainian border.

Although ostensibly the border between Russia and Ukraine was guaranteed by former Russian president Boris Yeltsin back in November 1990, neither Medvedev nor Russian Prime Minister Vladimir Putin has accepted this as definitive. The stumbling block is the border in the area of Kerch and the Azov Sea, which Russia would like to declare “open water.”

The diplomatic maneuvering is not very subtle: if Ukraine comes to the table to discuss a merger of Naftohaz and Gazprom — in reality a virtual takeover by the Russian company — then the border question can be quietly dropped. Given the current Russian leadership’s penchant for re-examining the issue of borders — after the war in Georgia three years ago it recognized two breakaway “republics” of South Ossetia and Abkhazia—the Ukrainians have to tread very carefully indeed.

None of these events should detract from the unpleasantness of the Yanukovych administration, but there is no question that his government has an reasonable desire to distance itself from the expensive gas deal negotiated in early 2009. Instead, it faces a loud and well-coordinated sideshow on the part of the ebullient Tymoshenko, who found time before her arrest to make her case on a YouTube video. Like the astute politician she is, she has exploited an opportunity to pose as a martyr for Ukrainian democracy, thereby reigniting what seemed to be a fading political future.

No doubt she deserves that chance and Ukraine can only benefit from a stronger opposition. On the other hand, the external danger is equally obvious and will only increase if the EU turns against Ukraine, as it has done against Belarus in recent months.

Thus far, the Ukrainian government has avoided commitment to Russia’s customs union (known as the Common Economic Space). But pressure is building. In the fall, a meeting of the Russia-Ukraine interstate commission will take place. During his meeting with Yanukovych at Sochi earlier this month, Medvedev made the following comment: “If you don’t mind, we’ll talk about whether Ukraine finds it reasonable to be part of any alliance with Russia.”

Under these circumstances, the stupidity of trying to remove Tymoshenko and her 2009 gas deal from the equation is understandable, if not forgivable.

This article appeared originally in the EDMONTON JOURNAL, 15 August 2011.

THE NEW GAS DEAL: THREATS AND RISKS FOR UKRAINE

Katja Malyhina

The harshest dispute in the history of the “gas wars” between Russia and Ukraine is over. On January 19, in Moscow, the Ukrainian energy supplier “Naftogaz Ukrainy” and its Russian counterpart “Gazprom” signed a new gas deal for 2009-2019. According to the agreement, Ukraine received a 20% discount on the negotiated gas price in 2009, which corresponds to the average European level. The fee for gas transit paid by Russia remained, however, unchanged from 2008 at US $1.7 cubic meters per 100 kilometers.

Introduction

Are there really any winners in this war? Ukraine’s sagging economy has become even more weakened due to the gas dispute with its neighbor. A number of large industrial companies, including the Odessa port plant and the chemical group “Stirol”, were shut down because Russia suspended its gas supplies to Ukraine. However, Russia has also suffered some damages. According to some estimates, Gazprom has endured financial losses of up to $1.5-2 billion. Limitation of Gazprom’s foreign exchange gains has strengthened devaluation tendencies in Russia. On January 20, the Russian ruble dropped to its lowest value in a decade (RUR32.2 to US$1). A number of European gas companies are seeking reimbursements from Gazprom for the halt in gas supplies. The most important consequence, however, is that the gas conflict essentially undermined the images of both Russia and Ukraine in the eyes of the European community. The President of the EU Commission Jose Manuel Barroso recently questioned the reliability of the both countries as energy suppliers to the EU.

Because of huge financial losses and Ukraine’s lack of compliance Moscow took a very tough position concerning future gas relations with Ukraine. The signed agreement has already tightened the prolonged political conflict in Kiev. President Viktor Yushchenko heavily criticized the contracts that were negotiated by Premier Minister Yulia Tymoshenko. Meanwhile, Tymoshenko called the conditions “unique.” But what makes new agreements really “unique”, and what impact will they have on Ukraine?

“Unique” Conditions

According to Tymoshenko, the gas contracts are unique because for the first time they were signed directly between the energy companies Gazprom and Naftogaz without any intermediary. Also, another precedent, the gas deal will regulate gas relations between Russia and Ukraine for the long term instead of annual negotiations. Finally, the gas prices for Ukraine are now tied to oil prices, following the example of European countries. Undoubtedly, the elimination of the dubious intermediary “RosUkrEnergo” (RUE) from the gas trade is a positive result for Ukraine. However, the result should not be solely attributed to the active endeavors of Tymoshenko. Gazprom was also interested in this decision. With the aim to reduce the profitability of the Nabucco project, Russia increased prices for gas from Central Asia, which made any intermediary services unprofitable.

The removal of the intermediary seems to be the only positive outcome for Ukraine from the new gas deal. The increase of gas prices to market levels from 1 January 2009 is a very unfavorable result. The gas price will be calculated quarterly according to a formula with the basic price of $450 per 1,000 cubic meters. Tymoshenko assured the public that the base price corresponds to the average European gas price for the first quarter of 2009. But if one compares quarterly prices for Ukraine announced recently by Naftogaz with the would-be European quarter average (that is without the 20% discount), then the annual average price for Europe would amount to $316 per 1,000 cubic meters. Gazprom, however, declared recently, that the average gas price for its European customers in 2009 would be $280. As a result, natural gas for Ukraine will be even more expensive than in Europe in the future. Moreover, with the high base price of $450 for Ukraine, Russia can offset the costs of expensive Central Asian gas and profitably sell it to Ukraine. In any case, Russia has done everything to get the utmost benefits from the negotiations.

Nevertheless, Prime Minister Tymoshenko did succeed in obtaining relatively low gas prices for the current year. According to Tymoshenko, the annual average price for Ukraine would be $228.8 per 1,000 cubic meters in 2009. The 20% discount granted by Gazprom will not be the only source of low average gas prices for this year. Naftogaz Ukrainy announced that it would buy the lowest amount of gas in the first quarter of 2009, when the gas price for Ukraine will be the highest (only 5 billion cubic meters at a price of $360 per 1,000 cubic meters). Naftogaz also lays claim to 11 bcm of RUE gas stored in Ukraine. RUE owed $1.7 billion to Gazprom for this gas, which was paid off by a complex maneuver: Gazprom made an advance payment for the same amount in lieu of transit fees, which Naftogaz then returned to pay off RUE’s debts. However, the Ukrainian energy company has faced problems with the transfer of ownership rights from RUE in its own country. If the transaction is successfully completed, the price for 11 billion cubic meters of gas would be only $154 per 1,000 cubic meters, which is $25 less than last year.

With all the discounts added together, Ukraine will pay about $9 billion for imported gas this year, while it will get only about $0.6 billion from Russia for gas transit through its territory. The actual amount of about $2.3 billion should be reduced by the aforementioned $1.7 billion, which Gazprom “paid” Naftogaz via RUE’s debt assignment. Leaving the transit rates at the same level as in 2008 and switching to the gas prices formula re-calculation illustrate the asymmetry of the contracts. It turns out that a 20% discount on gas prices comes together with a discount in around 60% on transit fees. Such a discrepancy will also remain over the next year, when the transit rate will be calculated according to the aforementioned formula. Gazprom has already announced that the price for transit will be about $2.66 per 1,000 cubic meters per 100 kilometers in 2010. For comparison, the average transit fees in Europe are around $4. According to the Ukrainian experts’ estimates, transit rates should be increased to US $5.11, in order to cover costs of the pipeline system. As a result, Ukraine subsidizes the transit of Russian gas.

The asymmetry of the contracts has also been emphasized by the Secretariat of the President. On the one hand, Ukraine is obliged to continue the transit of Russian gas even in the case of bilateral dispute, while Russia has the right to stop its supplies if needed. On the other hand, Ukraine will cooperate with Russia on the principle “take-or-pay”. This means that Ukraine is obliged to pay for the entire amount of gas specified in the contract, regardless of the amount actually consumed. At the same time, Russia may alter the volumes of gas transit and, consequently, their payment as it wishes. So another principle works here: “We pay only for actually transited gas”. Another positive development for Russia is the increased presence of Gazprom at the Ukrainian gas market. Founded in the spring of 2008, a subsidiary of Gazprom, “Gazprom sbyt Ukraina”, will get 25% of the Ukrainian gas market, equivalent to about 13.5 billion cubic meters. In 2008 the company was allowed to sell only 7.5 billion cubic meters of natural gas.

If Ukraine fails to pay on time, it will be immediately transferred to a 100% advance payment. According to the Secretariat of the President, Russia has developed such a scheme especially for Ukraine, as there is no other European country where such a clause exists. Overall, the asymmetry in the contracts shows that the political component still plays an important role in gas relations between Russia and Ukraine. Relations between two business parties are built according to the mutually beneficial conditions.

Impact on the Economy

Ukraine has thus signed long-term contracts on very disadvantageous conditions, which will adversely affect the already deplorable state of the Ukrainian economy. Taking into account the increased prices for imported gas, Naftogaz Ukrainy will have to increase prices for all consumer groups in the domestic market. Ukrainian industrial companies already paid a price of $300-330 per 1,000 cubic meters of natural gas in 2008, owing to various surcharges. However, 2008 was also a record year in terms of prices on Ukrainian products. Ukrainian companies, after all, were able to pay high gas prices and even get profits. But if gas prices for this year stay at least at the level of the previous year, the Ukrainian economy might encounter enormous problems of maintaining competitiveness. To prevent this scenario, Ukrainian politicians will need to continue subsidizing Naftogaz Ukrainy from the state budget. The budget for 2009 provides support for Naftogaz in the amount of about $0.9 billion in comparison with more than $1 billion used for this purpose in 2008. Under changing circumstances, this amount is likely to be increased again. The amount of state subsidy to Naftogaz will increase alone due to the fact that consumer gas prices were tied to the official exchange rate by the end of the year. While Naftogaz buys gas from Russia in U.S. dollars, it sells the fuel in Ukrainian hryvnya (UAH) on the domestic market. Devaluation of the UAH consequently leads to a further increase in subsidies. All this will provide an additional fiscal burden.

In future, it will be very difficult for Ukraine to pay for the imported gas on time. Last year Naftogaz was able to pay back its debt to Gazprom only because the company received loans from state-owned banks. The exchange rate broke down the day after Naftogaz bought in one transaction almost $1 billion from the National Bank of Ukraine at the end of 2008. Thus, if such practices are repeated, the further devaluation of the UAH and rising debt of the public funds are not excluded. Moreover, a threat of advance payment means that Ukraine would have to provide a significant part of its state budget for the payments to Gazprom, before it is taken up by taxes and customs.

The difficult financial situation of Naftogaz also complicates the problem of timely payment for gas bills. Naftogaz has been constantly on the verge of bankruptcy in recent years. The hope to improve the financial situation of the company by eliminating the intermediary is not justified. Even after the exclusion of RUE, Naftogaz may increase its presence on the gas market in the best case from 50% to 75% (25% is reserved for “Gazprom Sbyt Ukrainy”) and thus its revenue would be increased only by a quarter. But even this modest increase in revenue could be relinquished by decreasing demand for gas from industrial enterprises, which plan to buy only 24 billion cubic meters of natural gas instead of the usual 30 billion. It therefore seems quite unlikely that Naftogaz will be able to raise its income above last year’s $7 billion. In addition, many non-industrial consumers pay their gas bills with delays. Their common obligations to Naftogaz for the years 1998 – 2008 amount to approximately $0.8 billion. The debt of Naftogaz itself amounts to $9 billion, while about $2 billion has to be repaid this year. That is why one might expect a huge budget deficit of Naftogaz by the end of the year.

The one positive note for the economy of Ukraine might be the following. Because of the high gas prices, Ukraine will likely be forced to take appropriate energy saving measures. The Ukrainian economy is in general 2-2.5 times more energy-intensive than industries in Europe. In response to the crisis, some steel companies have already begun to replace natural gas with coke in their production. If Ukraine manages to reduce its energy needs, it could sell its own produced gas to Europe. Russian gas does not come into question because the re-export of this gas is prohibited. All these trends confirm the gloomy forecasts for the economic situation in Ukraine, which leads the world in the fall of industrial production, inflation, devaluation of national currency, and the decline of stock indices. Therefore, there is a high probability of default in Ukraine, according to the new UN report on the global economic situation.

New Gas Conflict Possible

A possible reason why the gas war between Ukraine and Russia was so intense in January 2009 is that Russia tried to realize the so-called “Belarusian scenario” in Ukraine. Two years ago, Belarus and Russia signed a five-year contract for the supply and transit of gas. Under the agreement Belarus switches to EU pricing levels in 2011. Until that time a discount system operates. In return for price concessions, Gazprom acquires a 50% share of the Belarusian pipeline system “Beltransgaz” by the 2010. Currently, Gazprom owns 25% of this company.

For Ukraine, too, a gradual transition to European gas prices within three years was initially foreseen. This was reflected in the memorandum signed in October 2008 between Putin and Tymoshenko. It is not excluded that Putin once again called for the Ukrainian pipeline system to be privatized or rent for a long term during the negotiations on the new gas contract this winter. However, according to Ukrainian legislation, the privatization of the pipeline system is prohibited. In addition, the system has great significance for national security of Ukraine. Indeed, Gazprom could become a monopolist over gas supply to Europe in every respect with the Ukrainian pipelines as Gazprom controls, or will control in the near future, all other transit routes of Russian gas to the EU. That is why Ukraine wants neither to sell nor to rent Russia its pipelines. Even the gas war at the beginning of this year did not force the Ukrainian authorities to surrender to Gazprom. Although Putin again appealed to the Europeans for an international gas consortium on common control of Ukraine’s pipeline system, Ukraine refused this proposal.

It is possible that, unlike Belarus, Ukraine agreed to the accelerated transition to the European market prices precisely for these reasons. Thus, “the Belarusian scenario” lost its relevance and the Kremlin has now to search for a new strategy. But what the “energy weapon” could not achieve could be perhaps attained through Ukraine’s falling deep into debt. The world economic crisis arrived just at the right time for the application of this tactic.

Disadvantageous conditions resulting from new gas contracts and the threat of economic collapse of Ukraine increase the likelihood of a renewed gas dispute. This could happen in two different ways.

1) Under the terms of the treaty, Russia has the right to halt its gas supplies to Ukraine if the latter does not pay on time. This step, however, could lead to technical problems with gas transit to Europe. In that case, the events at the beginning of 2009 would be repeated. The only difference would be that all the blame for delivery failure and responsibility for the resulting problems would be laid on Ukraine. In this way, Ukraine gets entrapped by the signed contract.

2) Russia would not halt gas supplies, but rather allow debts and fines to accumulate. Then Ukraine would probably be unable to refinance its gas debts. At some point Gazprom would try to acquire the Ukrainian pipeline system in exchange for debt forgiveness. There is already such a precedent: in the late 1990s Russia exchanged Ukraine’s gas debt for the long-term lease of Sevastopol naval base to the Russian Black Sea Fleet. To avoid such pressure from the Russian side, Ukraine could declare default. However, together with its inability to pay back debts, Ukraine might face difficulties in meeting its obligations on gas transit to Europe. In this case, Putin would set the question of the gas consortium high on the agenda again.

In conclusion, no matter how the situation develops, Russia has gained a position of strong advantage.

First published at “Ukraine-Analysen №50″, p. 5-9.

Update: Who is behind the leaked protocol on Russian-Ukrainian energy trade? The Ekonomichna Pravda version.

On June 7, Ekonomichna Pravda (EP), the business spin-off of Ukrains’ka Pravda, published an article entitled “Gas Subversion,” which seeks to refute most of the claims made in the Glavred piece discussed in our previous posting. While confirming the authenticity of the leaked document, citing some anonymous insider sources from the Naftogaz of Ukraine, the EP journalist disputes the main message of the Glavred article – namely, that the Ukrainian authorities are about to make serious concessions to Moscow, bringing the country’s energy system under control of the Kremlin.