Ukrainian Government Reconsiders Gas Policy

Based upon the record of the last eight years, Ukrainian governments and industrialists linked to them have sought deep discounts on the price of Russian gas in two ways, both ultimately self-defeating.

One way would allow Russia’s Gazprom to control Ukraine’s gas transit system through some “consortium,” several forms of which have been suggested. In this way, Ukraine would basically lose national assets (of which the gas transit system constitutes the crown jewels) to repay Russia in a barter-type deal for the discount on the gas price. Once national control over the gas transit system is lost, Ukraine would sooner or later have to cede other assets, so as to maintain a “preferential” price on Russian gas.

The alternative involves creating an intermediary gas trading company linked with Gazprom, and allowing that intermediary’s subsidiaries to take over the Ukrainian internal gas distribution system, as well as the lucrative parts of its internal gas market. This method does not immediately affect national ownership of the gas transit system, but leads to its de-capitalization and insolvency, as well as forcing the government to subsidize the population’s gas consumption through state budget deficits.

The first model was seriously considered during the final years of Leonid Kuchma’s presidency (2002-2004), with Gazprom and the then German Chancellor Gerhard Schroeder jointly proposing a “gas transport consortium.” Kuchma agreed to this proposal, but did not intend to deliver. The recently elected president, Viktor Yanukovych, campaigned on a promise to reduce the gas price by sharing out Ukraine’s gas transit system with Gazprom through a consortium. The new Prime Minister, Nikolai Azarov, carried the consortium proposal to Moscow on March 25 (EDM, March 26).

The second model, operated incompletely in 2002-2004 through the intermediary EuralTransGas and, in a fully developed form, in 2006-2008 via Gazprom’s notorious offshoots, RosUkrEnergo and UkrGasEnergo. Devised during Kuchma’s presidency, this model operated at full throttle under Viktor Yushchenko’s presidency, until terminated in January 2009 by then Prime Minister, Yulia Tymoshenko, after a long political battle. This model remains nevertheless under consideration as some of its protagonists have returned to key posts in the new government and at Naftohaz Ukrainy (EDM, March 22).

On the Russian side, Vladimir Putin played a direct role while president, first in proposing the gas transport consortium and later in arranging the RosUkrEnergo scheme. As prime minister, Putin cooperated with Tymoshenko in removing RosUkrEnergo and instituting market-based arrangements, under the supply and transit contracts signed in January 2009. President Dmitry Medvedev’s close confidant, Konstantin Chuychenko, served as Russian director of both EuralTransGas and RosUkrEnergo while Medvedev was Gazprom’s chairman, working in tandem with Dmytro Firtash on the Ukrainian side of the operation. Firtash’s network is now in control at Naftohaz under the new government.

Azarov’s Moscow visit failed on two counts: Putin refused to cut the gas price without a corresponding offset in the form of Ukrainian assets; and he dismissed the gas transport consortium idea in its present, inchoate form, demanding more binding proposals. Briefing Ukrainian media after his return, Azarov confirmed a further contentious issue. Gazprom wants Ukraine to maximize gas purchases and fill Ukrainian storage sites to capacity, ostensibly to prepare now for the heating season of fall-winter 2010-2011 (Interfax-Ukraine, March 26, 27).

Highly unusual in the early spring season, this demand seems designed to force Ukraine to adhere to the contract’s take-or-pay provisions, which could in turn quickly force Naftohaz Ukrainy into bankruptcy. Meanwhile, lower demand and market competition are forcing Gazprom and the Russian government to exempt some of the largest European gas importers from take-or-pay obligations. In November 2009, Putin and Tymoshenko had started a process of revising the bilateral contract’s take-or-pay stipulations, reducing volumes and renouncing fines. Forced by circumstances, Moscow has revised the contract in Kyiv’s favor with the Tymoshenko government, but is apparently stonewalling the Azarov government’s requests for revision.

A disappointed and indignant Azarov told Kyiv media that his government would itself determine Ukraine’s gas demand level and import volume: “that is all, we don’t need any extra gas, this is what any normal buyer does in market conditions” (UNIAN, Ukrainian Television Channel One, March 26).

Thus, the government seeks to escape from Gazprom’s take-or-pay system. However, the same government’s almost frantic quest for price discounts (contrary to Azarov’s “market conditions”) would cement Ukrainian dependency on Gazprom.

The Ukrainian government seems prepared to reject Putin’s suggestion that Ukraine join the Russia-Belarus-Kazakhstan Customs Union in order to qualify for cheap gas. According to Deputy Prime Minister Serhiy Tyhypko, the government would choose to pay the contract-stipulated price for Russian gas, rather participate in the Russia-led Customs Union. The government’s draft budget for 2010 envisages an average price of $334 per one thousand cubic meters of Russian gas during the current year, in line with the existing contract. Tyhypko recommends accepting this price, which would force Ukraine to introduce energy-conservation measures, increase domestic gas extraction, and seek access to liquefied natural gas (Inter TV, March 27).

Opposition forces led by Yulia Tymoshenko are warning that they would resist any attempt by the government to swap national assets such as gas pipelines for Russian gas at discounted prices. Tymoshenko’s BYUT and other opposition parties describe such a policy as corresponding with the interests of Ukrainian industrial oligarchs, grouped around the governing Party of Regions (Interfax-Ukraine, UNIAN, March 26, 27).

The government has not yet clarified its intentions regarding the European Union’s offer to assist the reform and upgrading of Ukraine’s gas transit system. Signed in March 2009 between the Tymoshenko government and the EU, the agreement envisages large-scale technical and financial assistance, which would guarantee the Ukrainian system’s independence and modernization. Ukraine’s recent presidential election has delayed the implementation of this agreement. Handling of this unique opportunity will test European credentials of this government and the industrialists who ultimately shape its decisions.