Publication: Eurasia Daily Monitor Volume: 2 Issue: 167

President Viktor Yushchenko’s September 7 decision to dismiss Yulia Tymoshenko’s government will certainly affect Ukraine’s crucial gas trade with Russia. Gas supply problems fraught with political complications are looming in Ukraine on the threshold of the heating-and-election season. The ruling coalition’s prospects in the March parliamentary elections depend to a significant degree on its ability to ensure reliable and affordable gas supplies to industry and the populace in the coming winter.

The Orange coalition’s margin of error in this respect is rapidly narrowing with the onset of autumn and amid political and business scandals within the coalition itself. This situation increases Russia’s political leverage and even Turkmenistan’s price leverage as gas suppliers to Ukraine during an electoral campaign de facto already under way.

On September 1, Gazprom in Moscow and Russia’s Ambassador Viktor Chernomyrdin (a former Gazprom chief) in Kyiv confirmed earlier signals that Ukraine may be charged the “European market price” of $180 per 1,000 cubic meters of Russian gas, more than triple the current rate. While the Russian officials also hinted that the price increase would take effect in stages, it seems clear that the increase on January 1, 2006, would in any case be massive, and that Moscow could seek economic and political concessions in return for limiting the price hike (Itar-Tass, Interfax, September 1).

Kyiv intends to resist the Russian demands but also needs to sign the gas agreement for 2006 before the end of this year. Thus, Ukraine’s ruling coalition seems caught in a politically no-win situation. Both the prospect of a massive price hike and uncertainty-breeding delays in securing an agreement will adversely affect the Orange coalition’s popularity ratings, particularly as the weather turns colder.

Russia does not sell gas to Ukraine commercially, but supplies gas to compensate Ukraine for the transit of Russian gas through Ukrainian pipelines to other European countries. Russian compensation gas to Ukraine is valued at only $50 per 1,000 cubic meters. Ukraine’s transit fee is also set far below European market rates, namely at $1.09 per 1,000 cubic meters of Russian gas per 100 kilometers of Ukrainian pipelines. These valuations enable Ukraine to receive some 23 billion cubic meters of gas annually, in compensation for transiting the usual annual volume of 115 to 120 billion cubic meters of Russian gas to other countries. The transit volume is planned to increase by a few percentage points annually from 2005 on, leading Kyiv to expect corresponding increases in the volume of compensation gas to Ukraine.

Gazprom, however, calls for a transition to market terms in the gas trade with Ukraine already in 2006. It offers to pay European-level cash fees for Ukrainian transit services and to sell gas to Ukraine at the going European price in hard currency. Due to soaring energy prices, Gazprom would be very much the net winner from those twin changes. A steep price increase would probably compel Ukraine to cut its intake of Russian gas. In that case, Gazprom would simply reroute to EU markets the volumes waived by Ukraine.

For its part, Kyiv insists on delaying the transition to market terms. Some top officials propose to retain the existing barter arrangements with Gazprom in 2006 and proceed to a gradual transition to cash payments from 2007 on. Fuel and Energy Minister Ivan Plachkov and Naftohaz Ukrainy chairman Oleksiy Ivchenko reaffirmed this position on September 6. Tymoshenko was more intransigent while prime minister: as late as September 2 she was calling for delaying any changes until the 2013 expiry of the Russian-Ukrainian framework agreement on gas transit (Interfax-Ukraine, September 2, 6).

Turkmenistan’s position adds to Kyiv’s problems. President Saparmurat Niyazov was due in Kyiv in September to sign a 30-year framework agreement on Turkmen gas deliveries to Ukraine. On September 6, however, Ukrainian officials announced that Niyazov has postponed the visit until October. Under the annual contract, Ukraine imports a whopping 36 billion cubic meters of Turkmen gas at the deeply discounted price of $44 per 1,000 cubic meters. A relic of bygone times, this pricing arrangement is due to expire in 2006. With Russia apparently poised to raise the gas price dramatically, Kyiv seeks to increase imports of Turkmen gas during the remaining months of 2005 and in 2006, while the discounted price lasts.

That old agreement with Turkmenistan is due to be superseded by the 30-year framework agreement from 2007 on. The draft under negotiation envisages the delivery of 60 billion cubic meters of Turkmen gas to Ukraine annually. Prices are to be determined in annual agreements. The annual delivery volume seems implausibly high, particularly since Turkmenistan is committed at least on paper to sell a comparable volume of gas to Russia annually in the same time frame. Russia’s transit monopoly on Turkmen gas is also fraught with potential risks to Ukraine, maximizing its dependence on supplies from Russia. Tymoshenko, while in office, advocated a transit route circumventing Russia, via the Caspian Sea, South Caucasus, and the Black Sea, to Ukraine and on to EU territory.

At the moment, Kyiv urgently needs a supply solution to tide Ukraine over the winter and through the elections as painlessly as possible. However, Moscow and Niyazov are aware that their bargaining leverage — which, in Moscow’s case, is political as well as economic — increases with every passing month as winter draws closer.

(Era [Kyiv], September 2; Interfax-Ukraine, September 1, 2, 5, 6, 7)