Is Ukraine Fit For The EU?

BRUSSELS, Belgium -- The European Union just helped put together a consortium of international banks to offer Kiev up to $3.6 billion in loans to buy Russian gas. The idea is to prevent a repeat of the January 2009 crisis, when Moscow shut down gas deliveries to Ukraine after Kiev failed to pay its energy bills.

The Brussels-brokered loan offer may encourage Kiev to clean up its corrupt gas sector.

As Ukraine transits 80% of Russian gas exports to the rest of Europe, the stoppage left many EU member states in the cold as well. Ukraine has been hit hard by the economic crisis and is having even more trouble than usual paying for Russian gas.

If Ukraine agrees to the terms of the loan, the money may help avert an immediate crisis and trigger badly needed Ukrainian reforms. At the same time, though, the funds will also "Europeanize" the next gas spat, potentially undermining EU-Ukrainian relations.

The money from the International Monetary Fund, the World Bank, the European Bank for Reconstruction and Development and the European Investment Bank will allow Ukraine to continue filling its gas reservoirs. Although the gas will technically belong to Ukraine, EU governments—having arranged the loans to purchase it—will expect Ukraine to maintain uninterrupted supplies.

If a crisis breaks out again and Kiev taps "European" gas for its own use, EU governments will be furious and the country's chances of EU membership will diminish. The gas loans may thus turn out to be the most important test of Ukraine's EU fitness as Brussels will expect the country to live up to its contractual obligations to deliver gas to Europe.

That would be a complete change from the crisis in January 2009, when the EU acted as a "concerned third party." Back then it treated the gas stoppage as a commercial and political dispute between Ukraine and Russia, helping to broker an agreement between the two parties

This will not be lost on Russia, which is not keen on Ukraine joining the EU. By turning off gas to Ukraine, Moscow could thus force on Kiev a draconian choice: Use stored gas to supply Europe and suffer economically or supply the domestic industry at the expense of EU customers and see its hopes of joining the bloc ruined.

Luckily for Kiev, Russia may now have more reason than ever to avoid another fight: Gazprom, the dominant Russian gas producer, lost over $1 billion in the January crisis, and its financial situation has worsened since then, mostly due to low gas prices on the back of the global financial crisis.

This also explains why Moscow has been a more constructive actor in recent months. It has paid in advance the entire annual fee for the rights to transit gas through Ukraine, and it is not claiming penalties (to which it is entitled) for Kiev taking fewer deliveries than it contracted.

But Russian energy maneuvers are only part of Kiev's problems. Gas is to Ukraine what cocaine was to Colombia—it has corrupted an entire generation of politicians, who grew rich skimming off profits from the gas trade. Billions are stolen through shady intermediaries who handle gas sales to Ukraine and yet more money goes missing in black trade that exploits price differences in gas retail prices on the Ukrainian market.

Trading companies buy gas ostensibly destined to poor households at cheaper, subsidized rates and then sell it to some steel smelter for a lot more. Moscow of course happily collaborates with Ukrainian politicians for a share of the booty. The EU increasingly questions whether Ukraine can ever be a reliable transit country, irrespective of what Russia does.

To dispel EU gas-supply fears, Ukraine has granted European monitors wide access to its gas facilities. But that will not be enough. Ukraine needs to reform its gas sector to end corruption and the expensive gas subsidies to households, which are bankrupting the country.

If it fails to do so, the pressure will grow on Ukraine to allow even greater European control over its gas system. EU officials have hinted at the possibility of forming a joint EU-Ukrainian consortium by encouraging EU gas companies to take a stake in Naftogaz, the country's oil and gas monopoly.

Europe's entry into a joint gas consortium, though, would be an imperfect solution. Those EU governments that are traditionally close to Moscow, such as Germany and Italy, would want to avoid a fight with Russia and probably insist that the country be included in the consortium.

But this would be tantamount to putting a fox in charge of a chicken coop. Russia has little regard for Ukrainian sovereignty, and it would surely try to use its control over the country's gas grid to undermine Ukraine's attempts to draw closer to the EU.

Far better for Ukraine to continue running its own gas pipelines. To that end, EU pressure on Ukraine to reform its gas laws to fight corruption and cut consumption would be more constructive than its direct involvement. The recent loan offer is a step in the right direction; it requires Ukraine to introduce reforms first in order to qualify for the money.

Kiev has of course failed to live up to similar reform pledges in the past. This time, things are different. Ukraine needs foreign money to keep the gas flowing. Also, until recently, Ukrainian leaders could semi-convincingly argue that reforms, which would raise domestic gas prices, should wait until the economy improves and until after presidential elections scheduled for January 2010.

But the World Bank is ready to spend part of its $500 million offer on mitigating the social impact of higher gas prices. So those concerns are no longer as relevant as they used to be.

The Ukrainian government has now started raising gas prices for households, although some subsidies remain. After the elections, there will be no more excuses for postponing further reforms. To remain solvent and truly autonomous, Ukraine needs to consume less gas and clean up its gas trading system.

As Europe could soon "own" part of Ukraine's gas reserves, a failure to reform could otherwise set up Kiev and Brussels for a serious showdown during the next gas spat and sink Ukraine's EU membership plans. Let's hope the EU-arranged loans will help concentrate minds in Kiev.

Source: The Wall Street Journal

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