Ukraine Economy: Gas trouble

KIEV, Ukraine -- Ukraine's finance minister, reportedly unhappy over the terms of the gas deal with Russia signed at the start of the year, has left the government. In the weeks since the deal was signed, Ukrainian dissatisfaction with the terms has grown considerably.

As a result, there is a growing likelihood that after the March parliamentary election there will be an effort to revise itwith potentially serious implications for Russian gas monopoly Gazprom, Ukraine, and Gazproms European customers.

According to a report by news agency Ukraiynski Novyny, Ukrainian Finance Minister Viktor Pinzenyk resigned on February 16th in protest at the January 4th gas agreement signed with Russia. This was refuted by the presidential administration, which said that Mr Pinzenyk had temporarily left the government in order to campaign ahead of the March 26th parliamentary election.

Mr Pinzenyk's press service was unavailable for comment, although a statement from the finance ministry said he was taking a short leave of absence (for the election). There is speculation that Mr Pinzenyk had offered his resignation but that the president, Viktor Yushchenko, refused to accept it. By stepping down, Mr Pinzenyk has more scope to criticise the government for failing to live up to the ideals of the Orange Revolution.

The deal reconsidered

At the time, the January 4th agreement appeared to be a reasonable compromise. Russia had cut supplies at the start of the year in order to force a change in the existing barter regime, whereby Ukraine took approximately 15% of the 145bn cubic metres of gas sent to central and Western Europe via its pipeline network. The notional prices within this trade US$50 per 1,000 cu metres for gas and US$1.09 per 1,000 cu metres per 100 km for transit.

The January deal provided for the monetisation of the gas trade. The transit fee was set at US$1.60 per 1,000 cu metres per 100 km for five years, while the price of Russian (Gazprom) gas was set at US$230 per 1,000 cu metres. Yet the average import price promised to Ukraine was a much more reasonable US$95 per 1,000 cu metres, on the basis that all its gas would be supplied by intermediary RosUkrEnergo, which would source most of Ukraines gas from central Asiaat a price of around US$60 per 1,000 cu metres.

As more details of the deal have come to light, it has become clear that the deal is far more favourable to Gazprom and Russia than it is to Ukraine. Although the deal brought Gazprom no closer to its strategic goal of gaining control or part-ownership of Ukraines export pipelineswhich are vital for the export trade which finances the rest of the gas monopolys businessit nevertheless broke the formal link between gas supplies to Ukraine and transit fees.

The US$1.60 transit fee set for five years is very reasonable compared with the rates that apply in eastern Europe and the CIS, not to mention to the EU. Furthermore, Gazprom has largely extricated itself from the Ukrainian market, which is much less lucrative than the markets further west and it no longer has any obligation to supply Ukrainethat responsibility now rests with RosUkrEnergo. Moreover, any gas that Gazprom sells to RosUkrEnergo for Ukraine will be highly profitable.

Uncertainty and opacity

For Ukraine, the deal now appears a poor one. The country has agreed to a relatively modest hike in the gas transit fee that does little to offset the sharply higher import bill. Moreover, the US$95 per 1,000 cu metres price for gas is only guaranteed for the first half of 2006. Thereafter it could rise substantiallyand is likely to do so, since the Turkmen government has understandably responded to the sharp rise in Russian gas prices to Ukraine by demanding that it too receive more for its gas; US$100 per 1,000 cu metres is the price most often mentioned, and this does not include any transit fee that Gazprom may apply.

It is conceivable, moreover, that Gazprom could restrict volumes of Turkmen gas going to Ukraine via its pipelinesciting capacity constraintsand thereby force RosUkrEnergo to buy more Russian gas priced at US$230 per 1,000 cu metres.

In this case, it seems implausible that RosUkrEnergowhich is 50% owned by Gazprom subsidiary Gazprombank, and 50% owned by unnamed individuals represented by Raifeissen Bankwould consent to subsidise gas prices for Ukraine.

As a result, it is highly probable that the price of gas imports to Ukraine (are needed to meet 75% of domestic consumption) will rise even higher. For this reason, Mr Pinzenyk warned on February 14th that Ukraine was in danger of failing to meet its budgetary targets; he estimated that an increase in gas import prices after June would cost the budget at least US$600m.

Ukrainian dissatisfaction with the deal is not solely focused on price. The role of RosUkrEnergo has also attracted considerable criticism. Until the price of Turkmen gas rises, RosUkrEnergo will be making a profit of at least several hundred million dollars on the gas trade. If the intermediary was a joint venture between Gazprom and Ukraines gas utility, Naftohaz Ukrainy, half of that profit would flow into the Ukrainian company.

Instead, it will flow into the bank accounts of RosUkrEnergos unnamed beneficiaries, some of whomaccording to speculationare close to senior Naftohaz managers. After insisting for weeks that the January 4th deal was good and transparent, Mr Yushchenko has recently been forced to admit its failings. Government efforts to reveal the identities of the non-Gazprombank beneficiaries of RosUkrEnergo have failed. So too, thus far, have the authorities call for RosUkrEnergo to be sidelined in favour of a new Gazprom-Naftohaz Ukrainy venture that would fulfil the same role.

With the benefit of hindsight, it thus appears that the January 4th agreement offered some significant gains for Gazprom without equivalent advantages for Ukraine. Indeed, it seems odd that Ukrainian negotiators, if they focused beyond a six-month horizon, could have agreed to the deal. The most generous conclusion to be drawn from their performance is that they did not expect the January agreement to last beyond the March parliamentary election.

Not nearly settled

Further Russian-Ukrainian gas agreements have reportedly been signed since January 4th; the details of these have not been released. However, it seems improbable that they could change the fundamental problemsnamely the role of RosUkrEnergo and the prospect that Ukrainian prices will rise significantly after June.

If RosUkrEnergo had been sidelined, there would be no reason to keep that a secret; and if its anonymous owners had been replaced by Naftohaz Ukrainy, the Ukrainian government would be desperate to publicise the fact and so dispel notions that it has tolerated, or is in some way complicit in, corruption.

Likewise, it is not clear how subsequent deals could give Ukraine a multi-year price guaranteethere is little reason for Turkmenistan to guarantee five years of low-priced gas, nor for Gazprom. And without a price guarantee from suppliers, RosUkrEnergo cannot profitably supply gas to Ukraine at an average price of US$95 per 1,000 cu metresand why should its owners be prepared to make a loss on the deal?

For these reasons, there is a growing likelihood that Ukraine will seek to renegotiate the terms of the gas deal after the parliamentary election. Such a negotiation is unlikely to be easyalthough it could, conceivably, be smoothed by the emergence of a more pro-Russian government in Ukraine.

The initial indications from Russias government are that Moscow is not prepared to sideline RosUkrEnergo; rather, it prefers to see Gazprom replace Gazprombank as the Russian representative and has suggested that Naftohaz should buy out the Ukrainian shareholders to become Gazproms partner. Yet it is not clear that the investors represented by Raifeissen are prepared to sell; even if they were, the political and financial price may be too high for the Ukrainian government to accept.

Moreover, to improve Ukraines prospects with regard to gas prices would involve Gazprom giving up some of its gains from the January 4th agreement and would require Turkmenistan to forgo future price rises. Here too the prospects seem grim. It is quite conceivable that, in the search for greater leverage, Ukraine would try to reopen the question of transit fees.

This would be badly received by Gazprom, as the transit fee element is arguably Gazproms greatest achievement in the January 4th agreement, and thus it would set the stage for a renewed stand-off that could threaten supplies to Western Europe. The one consolation is that this would not happen during the coldest winter seen across Europe in decades.

The longer-term difficulty for Ukraine arising from this situation is that the economy remains hooked on under-priced gas and the country is dependent on Russia to provide it. Although Ukraine is unlikely ever to be able to do without Russian gas supplies, the relationship would be fundamentally different if the gas trade was fully transparent and conducted on a cash basis at a market price.

The fact that Ukraine remains dependent on cheap gas that Russia supplies or controls gives Russia leverage over Ukraine, and the terms of the current trade are an invitation to corruption. While this remains the case, the stability in the Ukrainian-Russian relationship that Gazproms EU customers yearn to see is likely to remain beyond reach.

Source: ViewsWire Eastern Europe