9. RUSSIA-UKRAINE ON THE BRINK

ANALYSIS AND COMMENTARY: By Peter Lavelle
United Press International (UPI), Moscow, Russia, Wed, Dec 28, 2005

MOSCOW – With hours left before the current bilateral agreement on
natural gas deliveries and transit to Europe end, Russia and Ukraine face
a crisis that could have serious international implications.

Energy giant Gazprom is demanding Ukraine pay a fourfold price increase for
gas deliveries staring next year. Ukraine says this is an exorbitant demand
that is politically motivated.

Three weeks ago, Gazprom wanted a new natural gas contract with Ukraine
starting next year that includes abandoning the current barter system of
payments for gas transportation services. It also demanded Kiev pay a price
for natural gas more in line with the firm’s European customers — $150-160
tcm vs. the $50 tcm Naftogaz, Gazprom’s Ukrainian counterpart, pays.
Ukraine said this price increase is out of the question and European-level
pricing should be phased in over the next five years.

Due to what Gazprom calls intentional stalling on the Ukrainian side and
the company’s renegotiation of gas contracts with other former Soviet
states, the price was later increased to $230 tcm. What was colloquially
called the Russia-Ukraine “gas war” of words now is interpreted as an
almost literal conflict. Gazprom has the upper hand in the dispute, but
Ukraine does have considerable wiggle room.

In 2004, Ukraine’s natural gas consumption exceeded 70 bcm while domestic
production was 20 bcm. Gazprom covered part of this deficiency by providing
Ukraine 29.2 bcm as payment to Naftogaz for transportation services.

Ukraine’s competitive advantage in dealing with Gazprom is its location.
The firm transits its natural gas through Ukraine to sell in other foreign
markets. Naftogaz is key to Gazprom’s international operations and this is
the leverage Ukraine has in any agreement over the price it pays for
Russia’s natural gas, as well as transit fees.

Gazprom’s dependence on Ukraine is almost absolute. It earns most of its
income from exports, and its main export route runs directly across
Ukraine. Naftogaz has an extensive network of pipeline corridors that end
in Europe. Gazprom shipped 138 bcm of its total European exports of 153.2
bcm through the Naftogaz pipeline system in 2004. Gazprom pays Ukraine a
transit tariff of $1.09/mcm/100 km and has proposed $1.75/mcm/100 km.
Ukraine is demanding an increase to $3, which would essentially cover the
cost of the country’s imports from Russia.

In an effort to go around Ukraine, Gazprom plans to build a pipeline that
will link the Russian port of Wyborg and the town of Greifswald, Germany.
It will initially provide gas to Germany, and offshoots may subsequently be
built to link it with several other countries, including Britain. The
pipeline is forecast to deliver 20 bcm of natural gas a year, a trifle
compared with its present total export regime.

Ukraine’s leverage in these negotiations has become a political issue in
the country’s parliamentary elections scheduled for March 2006. President
Viktor Yushchenko has no choice but to be reminded of what he said during
the Orange Revolution last winter: Ukraine should have economic relations
with Russia based on market principles, while protecting the country’s
economic sovereignty.
YUSHCHENKO’S POSITION IS CLEAR
How his political opponents are approaching the dispute is odd at best.
Former Prime Minister Yulia Tymoshenko, who was nicknamed the “gas
princess” on the back of allegations she was involved in shady deals that
included acquiring and reselling natural gas transited through Ukraine, has
offered to act as intermediary. It is doubtful Yushchenko has any interest
in promoting a political opponent in this critical issue. Gazprom certainly
is not interested in dealing with Tymoshenko — Russia’s prosecutor general
closed a criminal investigation against her on Tuesday only because the
statute of limitations expired.

Former prime minister and presidential candidate Viktor Yanukovych’s
position on the deadlock verges on the bizarre. He has supported the
Russian side in this conflict, though his supporters in the east of the
country would be hit hardest by the price increase.

What is really in play and how will this conflict be resolved?

[1] First, most of the talk and bitterness about the negotiations have come
from the companies most involved — Gazprom and Naftogaz. When

Gazprom announced its new price demands, politicians entered the fray.

Presidents Vladimir Putin and Yushchenko have sought to cool tempers.
Putin’s statement that the gas dispute should not hinder Russo-Ukraine
relations appears to be directed to Europe to apply pressure on Ukraine to
compromise. In the end, neither president has an interest in offending
Europe — Gazprom’s most-important customer.

[2] The second issue is how this dispute is perceived by the other former
Soviet republics that import Russian natural gas. The drawn-out
negotiations with Ukraine have sent the powerful message the days of cheap
Russian natural gas are coming to a close. Moldova, Georgia and the three
Baltic states — and even Belarus — have watched the spat closely and come
to the conclusion playing hardball with Gazprom is a losing proposition.

[3] Third is the issue of control over natural gas pipelines. The issue that is
making the headlines is natural gas prices, but the subtext is management
and ownership of pipeline lines transporting Gazprom’s gas. The company is
offering to accept stakes in Ukrainian enterprises — in particular the
country’s natural gas transportation network — instead of cash payment for
natural gas. Gazprom appears interested in acquiring control over the
remaining parts of the Europe-bound gas transportation network, even
accepting a price of $46.68 per 1,000 cu m from Belarus last week after
Minsk agreed to hand over 50 percent of its gas transport company,
Beltransgaz. This issue, of course, is delicate for Ukraine — pipelines
are the country’s most important card in this dispute.

As the clock ticks away, Russia and Ukraine remain at loggerheads. Gazprom
has repeatedly stated it will turn off the taps at 10 a.m. Jan. 1 if there
is no new agreement. This could happen, but for only a day or so as a way
for both sides to prove a point. However, an agreement is inevitable and
everyone involved know this. What is most likely to happen is an initial
three-month agreement to conclude negotiations. This will calm passions in
two ways. The conflict will be removed from the center of Ukraine’s
parliamentary campaign and allow a more business-like atmosphere to
dominate the talks. All parties in the gas war have made their point, now
consumers expect a deal. -30-

Peter Lavelle is Moscow-based and a political commentator for
“Russia Today” television.

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