Ukraine Bends Market Economics for Energy Supply Diversification

KIEV, Ukraine -- Ukrainian officials continue what looks like almost frantic attempts to diversify oil and gas supply sources in order to reduce dependence on Russian supplies. Driven mainly by reasons of state, these efforts seem to overlook market economic criteria such as commercial profitability and return on investments, and they may well founder on these criteria.

Ukrnafta oil company president Ihor Palytsa has made public a proposal to develop an oilfield in Kazakhstan as a joint venture with that country's KazMunayGaz state company. Palytsa expects this field, as yet unexplored, to produce 1 million tons of oil annually within three years of the start of development work. Meanwhile, Ukrainian officials consider involvement in Azerbaijan at some onshore oilfields, also with meager potential, to be technologically uncomplicated, and commercially unattractive to other companies.

It seems, however, difficult to envisage that the ventures could be profitable at this level of output, or that this volume could begin to make a difference in terms of supply diversification for Ukraine. The state holds 50% plus one share in Ukrnafta through Naftohaz Ukrainy, with 42% held by a group of companies linked to Pryvatbank, which also controls the Prikarpattya oil refinery in Nadvirna.

Prime Minister Yulia Tymoshenko proposes construction of a pipeline from Iran via Turkmenistan, to carry gas from both countries to Ukraine. Speaking at a press conference in Kyiv, Tymoshenko called on Azerbaijan and Georgia to join a gas transit consortium that would build such a pipeline, and assumed aloud that Gaz de France would take part in such a consortium. The French company signed on June 14 an agreement with the Ukrainian government to form a joint planning group on developing alternative routes for supplying gas to Europe.

Tymoshenko's proposal is a modified version of President Viktor Yushchenko's two proposals to Turkmenistan President Saparmurat Niyazov, in Ashgabat in March and at the CIS summit in Moscow in May. Both political leaders as well as top executives of the state energy sector underscore the need to extricate Ukraine from dependence on Russia, but they stop short of addressing funding and commercial issues in connection with such projects.

At the moment, Ukraine is falling deeply into financial arrears to Turkmenistan for gas. On June 20 in Ashgabat, Niyazov presented the visiting chairman of Naftohaz Ukrainy, Oleksiy Ivchenko, with a $562 million bill for unpaid gas. The new Ukrainian government incurred most of this debt in January-May 2005. Under the bilateral contracts, Ukraine pays 50% of the Turkmen gas bill in cash and the other 50% in goods (mainly steel pipes and other metallurgical articles) and services (mainly construction works, again involving steel inputs). In May, Yushchenko promised Niyazov to find ways of settling the debt before the end of that month. This has not been accomplished, however.

As one method to offset those arrears, Ivchenko now suggests that Ukraine would deliver steel this year to Turkmenistan at last year's prices, i.e., at a significant discount, in the barter half of the gas bill. Both Yushchenko in March and Ivchenko in June have suggested that the barter portion of the payment be increased, and the cash portion correspondingly decreased. Niyazov has turned down these proposals, describing them scathingly as Soviet relics incompatible with market economics. Naftohaz Ukrainy now intends to prospect and possibly to develop gas fields in Turkmenistan in order to supply Ukraine. Whether the company or the Ukrainian state budget can provide the necessary investment seems far from certain.

Meanwhile, Russia's Gazprom claims to have identified some hitherto unknown Ukrainian arrears to the tune of $1.2 billion, for past deliveries of 7.7 billion cubic meters of Russian gas to Ukraine. Russian President Vladimir Putin seized the occasion to upbraid Ukraine publicly for this. Ukrainian State Security Service chief Oleksandr Turchynov has launched an investigation targeting former officials of Naftohaz Ukrainy as well as two gas trading companies that had handled the transit of Turkmen gas to Ukraine, serving as Gazprom fronts with links to Kyiv officials.

Source: Eurasia Daily Monitor

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