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Analysis: Ukraine-Russia gas dispute

Posted by Kris Roman on March 6, 2009

by John C.K. Daly

The new year opened with Russia halting natural gas deliveries through Ukraine to Eastern Europe and points west, reminding the European Union that its Russian gas imports are hostage not only to bilateral economic disputes between Moscow and Kiev but to Ukrainian domestic politics as well. The stoppage, which began Jan. 1 when Russia first diminished gas flows before halting them completely six days later, directly affected 18 nations during one of Europe’s coldest winters in years.

 

EU hopes that the issue was resolved by the 10-year contract signed Jan. 18, covering both natural gas supplies and transit issues, have been dashed. Under the terms of the agreement, Ukraine received a 20 percent discount from the fees that Gazprom charged its European customers. While still giving Kiev a preferential rate to EU customers, the short-term effect was to effectively double the rate paid by Ukraine for Russian gas, from $179.50 per thousand cubic meters to $360 per tcm. The rate would be recalculated every three months. Because of the global recession and subsequent downward trend of energy prices, some analysts were predicting that Ukraine’s price by the early summer would fall to $250 per tcm or less. The contract became a political football between Western-leaning President Viktor Yushchenko and Prime Minister Yulia Tymoshenko, who brokered the deal.

The dispute’s resolution proved short-lived, however. Citing underpaid bills, on March 5 Russian Prime Minister Vladimir Putin threatened again to turn off the taps on March 7 if the outstanding balance was not paid in full, even as the Ukrainian natural gas concern Naftogaz scrambled to assemble the necessary funds. Leaving neither Brussels nor Kiev in any doubt about his intentions, Putin stated that Ukraine’s failure to settle the bill in full “will lead to the stoppage of our energy deliveries to our customers in Ukraine as well as customers in Europe.”

What makes this dispute even more ominous for Brussels than the January quarrel is that it has no other immediate energy options and is occurring as the Ukrainian economy goes into free fall amid an increasingly bitter political wrangle between Yushchenko and Tymoshenko.

Regarding personal negotiations with Moscow with distaste, Yushchenko reacted to Tymoshenko’s triumph by criticizing her for not negotiating a lower price and threatening to revoke the agreement with his compliant National Security Council, only retreating after substantial pressure from Brussels, with which his government was negotiating funding.

The latest crisis began March 4, when armed officers from Ukraine’s Sluzhba Bezpeky Ukrayiny, the Ukrainian government security agency and local successor to the Soviet KGB, raided the central offices of the national joint stock company Naftogaz in Kiev on the pretext of investigating abuses, even as Naftogaz was working on resolving its Gazprom debt.

The SBU is answerable directly to the president. Interestingly, in the aftermath of the earlier pricing dispute, Yushchenko appointed Valerii Khoroshkovskyi as SBU first deputy chairman on Jan. 28. SBU spokeswoman Maryna Ostapenko confirmed that SBU investigators arrived at the Naftogaz offices before adding that all questions about the investigation should be referred to Khoroshkovskyi.

The pressure continued, as the following day SBU officials tried to gain entry to the offices of Ukrtransgaz, the transit affiliate of Naftogaz. According to an Ukrtransgaz spokeswoman, the raiders produced no documentation or warrants, and were only persuaded to leave the premises after an hour following discussions with Rada (parliament) members loyal to Tymoshenko who had hurried to the scene, who presented them with a cease and desist court order.

In a clear sign of the political nature of the incursion, the second raid followed Moscow confirming that Kiev Naftogaz in fact had paid in full its $360 million bill for Gazprom’s February gas deliveries. Naftogaz’s legal department head Serhiy Davydenko said the SBU agents were seeking the original Jan. 18 contracts, while Kiev swirled with rumors that they also were seeking incriminating evidence on Tymoshenko.

Tymoshenko herself was in no doubt about the motivation behind the raids, telling her Cabinet on March 5, “The prosecutor’s office is doing nothing because it has its own interests, the SBU is blatantly breaking the law and the president is covering up for them. This is not merely a violation of the constitution, but in essence the destruction of the very foundation of the state’s legal norms.”

Throughout the former Soviet space, energy and corruption are frequently as close as Siamese twins, and Ukraine is no different. The raids were part of a political struggle over the disputed ownership and possible embezzlement of 6.3 billion cubic meters of gas worth $800 million at current prices. RosUkrEnergo, a shadowy company based in Zurich, had brokered Russian gas for sale to Ukraine before the January spat and claims ownership of the gas delivered in February, while Naftogaz also claims ownership, having paid for it. Gazprom owns 50 percent of RosUkrEnergo, with Ukrainian billionaires Dmytro Firtash and Ivan Fursin the remainder.

Tymoshenko’s agreement cut RosUkrEnergo out of the loop, which made some powerful people in both Moscow and Kiev unhappy. On March 4, immediately before the Naftogaz raid, while in Paris for talks with French President Nicolas Sarkozy, Tymoshenko stated that customs officials had cleared Naftogaz’s legal ownership of the discounted gas purchased from Gazprom in the aftermath of the January settlement.

The core of the political bitterness between Yushchenko and Tymoshenko is his plummeting popularity ahead of Ukraine’s upcoming presidential elections, tentatively scheduled for January 2010. Tymoshenko has made no secret of her intention to run and win, while in Paris telling the French newspaper Le Monde that the election would result “not in my destruction but in his (Yushchenko’s) political suicide.”

Polling data suggest Yushchenko’s deep loss of support; a January Democratic Initiatives Foundation survey determined that if the presidential elections were held in late December 2008 or early January 2009, Yushchenko would have won less than 2.9 percent of the vote.

Accordingly, a political scandal tying Tymoshenko to corruption in Ukraine’s natural gas industry would be political manna from heaven for the embattled Yushchenko. SBU head Khoroshkovskyi said as much during a March 5 press conference, telling journalists when asked about possible illegal actions in Ukraine’s gas sector, “No signs of the prime minister’s direct involvement have been registered so far,” before adding ominously, “All are equal before the law, and Yulia Volodymyrivna (Tymoshenko) is no exception.”

Yushchenko’s immediate goal is to ride out the crisis until March 23, when his government is holding a high-level conference with EU nations to discuss modernizing Ukraine’s decrepit Soviet-era gas transit pipelines, but Yushchenko comes to the bargaining table empty-handed.

The Ukrainian economy is on the verge of collapse; compared to January 2008, production has declined 34 percent, inflation is running at 23 percent, and the hryvnia, Ukraine’s currency, has depreciated by about 50 percent in relation to the dollar. Unemployment is soaring and the economy is expected to contract by 7 percent this year, while last week Standard & Poor’s concluded that Ukraine was so likely to default that it downgraded its short-term foreign currency sovereign credit ratings to CCC-plus/C from B/B, on par with Pakistan as a default risk.

Ukraine last year secured a $16.4 billion International Monetary Fund bailout loan to avert a default and stabilize its banking system and received the first $4.5 billion payment in November, but then approved a budget deficit of 5 percent of gross domestic product that put the second tranche of $1.9 billion in jeopardy, as the IMF had demanded a balanced budget.

If Yushchenko continues his vendetta with Tymoshenko, then the question seems not to be whether his estranged prime minister will win the presidential elections, only how beaten down the Ukrainian economy will be when she does.

As for Europeans and their gas imports, the fundamental question amid the relentless brinkmanship between Moscow and Kiev is between spending significant money to improve Ukraine’s pipeline infrastructure through which they receive 42 percent of their Russian gas imports, or swallowing hard and digging deeper to build alternative lines. Eurocrats might recall the warning that Putin delivered on Dec. 23, before the Ukrainian dispute flared up: “The era of cheap energy resources, of cheap gas, is, of course, coming to an end.”

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