Publication: Fortnight in Review Volume: 6 Issue: 20

Meeting with Russian President Vladimir Putin on October 16 in Sochi, Ukrainian President Leonid Kuchma officially agreed to hand over to Moscow an as yet unspecified stake in Ukraine’s gas transit system. That system of pipelines, pumping stations, and storage sites is worth US$20-25 billion by Kyiv’s estimates. It handles annually up to 120 billion cubic meters in Russian gas exports to European countries. Those exports probably constitute Russia’s single largest source of hard currency revenue. The transit system is also key to Ukraine’s own gas imports and energy balance.

Official communiques from the Sochi meeting misleadingly termed the deal-in-the-making a “privatization.” The likely beneficiary, however, is Russia’s Gazprom monopoly. The communiques presented this development as a Ukrainian initiative which Russia “accepted.” In fact, Kyiv took this step under considerable pressure and after running out of options. Kuchma’s move was expected and had been coordinated with the Ukrainian parliamentary leadership. Last month, senior figures in the parliamentary majority introduced draft legislation on the sale of ownership shares in Ukraine’s gas transit system.

The president, the cabinet and the parliamentary leaders hope to obtain a three-way deal which would involve major West European companies acquiring stakes in Ukraine’s gas transit system. Such a development would constitute a genuine, if partial, privatization as well as political counterbalance. Failing that, Ukraine’s economic and political vulnerability to Russia would increase from what is an already uncomfortable level.

A number of factors converged to push Ukraine onto this risky path. First, the arrears to Gazprom are mounting and are compounded by penalties on Ukraine for siphoning off some of the westbound Russian gas from transit pipelines. Arrears plus penalties have hit the US$2 billion mark, up from US$1.4 billion in January 2000.

The second factor is Ukraine’s need for Russian consent to planned imports of gas from Turkmenistan. Kuchma recently signed an agreement with President Saparmurat Niazov for the delivery of 35 billion cubic meters of favorably priced Turkmen gas to Ukraine between now and the end of 2001. To clear the way for the transit, Moscow seeks participation in “privatizing” Ukraine’s pipelines.

The third factor is a plan by Germany, France and Italy, with the support of the European Union, to augment imports of Russian gas by at least 30 billion cubic meters annually over a 20-year period. Some of that gas would in fact be Turkmen gas bought and resold by Russia. Gazprom insists on the laying of a new pipeline that would bypass Ukraine. The rerouting would slash Ukraine’s transit revenue, which currently takes the form of Russian gas in lieu of cash payments. It would also undermine any Ukrainian counterleverage to Russian pressures.

The bypass route would have to traverse Poland and Slovakia. The Polish government has initially refused to enter into any agreements detrimental to Ukraine. But Poland will probably have to reconsider that position in order to avoid jeopardizing her own bid for EU membership.

The fourth factor is an increasingly pressing need for modernizing the Soviet-era transit pipelines in Ukraine. Such a project is beyond Ukraine’s and/or Russia’s resources. Western technology and capital can be enlisted only to the extent to which the Ukrainian pipelines matter to Western Europe’s energy supplies. That in turn depends on the extent of Russia’s involvement as the source of supply. And Russia seeks co-ownership of Ukraine’s pipelines as part of the overall deal.

The fifth factor is a short-term one, and thus perhaps the most pressing. As winter looms and Ukraine faces energy shortages, Moscow is declining to renew supply contracts unless Kyiv cedes ownership shares in the energy sector as payment for past deliveries. Recently, four negotiating rounds on debt settlement and contract renewal saw only stonewalling. Moscow delegated mere civil servants–instead of policy-making officials–to those rounds; and seemed determined to drag the talks into the winter for maximum leverage on Kyiv. In early October, Ukrainian Parliament Chairman Ivan Plyushch–a staunch supporter of national independence–declared that Ukraine “can not go through the winter without Russia.” On October 9, Gazprom’s affiliate Itera company cut the already meager deliveries to Ukrainian heating plants, “due to low payment levels.” By mid-October, Kuchma decided to fly to Sochi with the “offer” that a debonair Putin “accepted” in front of television cameras.

Crude Russian pressures may have been aided by gentle West European ones. Ukraine’s Security and Defense Council Secretary, Yevhen Marchuk, hinted at the latter by stating that friction with Russia over fuel transit to Europe would jeopardize Ukraine’s own aspirations to draw close to the EU. More openly, Putin stated in Sochi that Ukraine’s status as a transit country for westbound energy supplies depends on Kyiv’s coming to terms with Moscow; and “if we agree with Ukraine, we can then include Ukraine in the cooperation between Russia and Western Europe.” Putin spoke and acted as if he understood that Ukraine had been placed in the position of dealing with the West Europeans through Russia in this matter.

The deal has some way to go before consummation, however. The basic legal and financial issues must still be negotiated, as must the possible acquisition of stakes by Western firms.

The Putin-Kuchma understandings in Sochi are not without their silver lining. All of Ukraine’s arrears to Russia will count as state debts, rather than corporate ones. That should theoretically open the way for Russian consent to debt restructuring along the same lines that Moscow seeks for itself from the Paris Club of creditor countries. The other silver lining is Russian consent to the transit of Turkmen gas at nonextortionate fees. But these are “understandings in principle”–i.e. nonbinding.