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Mr. E. Morgan Williams, Publisher and Editor
Washington, D.C., WEDNESDAY, JANUARY 11, 2006

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Almost half the deputies of Yushchenko’s party Our Ukraine chose not to vote.
By Tom Warner in Kiev and Financial Times reporters
London, United Kingdom, Tuesday, January 10 2006

Maria Danilova, AP Worldstream, Kiev, Ukraine, Tue, Jan 10, 2006

TV 5 Kanal, Kiev, in Ukrainian 1100 gmt 10 Jan 06
BBC Monitoring Service, UK, in English, Tue January 10, 2006

Press Office of President Victor Yushchenko
Kiev, Ukraine, Tuesday, December 10, 2006

UNIAN, Kyiv, Ukraine, Tuesday, 10 January, 2006.

Experiencing most serious political crisis in all its history
Radio Mayak, Moscow, in Russian 1500 gmt 10 Jan 06
BBC Monitoring Service, UK, in English, Tue, Jan 10, 2006

ANALYSIS: Dr. Edilberto Segura

Director & Chief Economist, SigmaBleyzer
President, Advisory Board, The Bleyzer Foundation
The Action Ukraine Report (AUR), Number 639, Article 7
Washington, D.C., Wednesday, January 11, 2006

THINKING GLOBAL: By Frederick Kempe
The Wall Street Journal, New York, NY, Mon, January 9, 2006

EDITORIAL: The Moscow Times
Moscow, Russia, Tue, Jan 10, 2006. Issue 3327. Page 9.

COMMENTARY: By Jan Kalicki and David Goldwyn
Financial Times, London, United Kingdom, Mon, January 9 2006


OP-ED: By Rajan Menon and Oles M. Smolansky
Los Angeles Times, Los Angeles, California, Sun, January 8, 2006

Paul Robinson says that Russia was only doing what the EU
had demanded when it increased its gas prices this week
: By Paul Robinson, The Spectator magazine online
London, United Kingdom, Saturday, January 7, 2006

The Ukraine crisis is a post-Soviet tale of Jekyll and Hyde. By day,
good Dr. Putin tries to remake Russia as a modern country. By night…
By Michael Meyer, Newsweek, International Edition
New York, New York, Edition, January 16, 2006

Last week’s reduction in gas supplies to Europe threw Gazprom, the
scariest company in the world, into the limelight. Sylvia Pfeifer looks
at the energy giant and the political influences on it
By Sylvia Pfeifer, Telegraph, London, UK, Sunday, January 8, 2006

With Putin flexing his muscle in the energy market, investors should think
twice before taking a stake in state-controlled Rosneft, writes Conal Walsh
By Conal Walsh, The Observer, London, UK, Sunday January 8, 2006

London, United Kingdom, Saturday, January 7 2006

ANALYSIS: By Thomas Catan, Financial Times

London, United Kingdom, Sunday, January 8 2006

FT COLUMNIST: By Wolfgang Munchau, Financial Times

London, United Kingdom, Sunday, January 8 2006
Almost half the deputies of Yushchenko’s party Our Ukraine chose not to vote.

By Tom Warner in Kiev and Financial Times reporters
London, United Kingdom, Tuesday, January 10 2006

The Ukrainian parliament on Tuesday voted to oust Prime Minister Yuri
Yekhanurov’s government over last week’s gas deal with Russia which in
effect doubled the price of gas to the country.

A no-confidence motion was backed by 250 deputies in the 450-seat
parliament, outraged by the deal with Russia. Mr Yekhanurov claimed

the vote was not legally binding and vowed to continue in office until
parliamentary elections, due in March. Analysts disagreed whether
parliament had the power to dismiss the cabinet.

Yulia Tymoshenko, the former prime minister of Ukraine and once a close
ally of President Viktor Yushchenko, backed opposition efforts to sack
officials who agreed to the sharp rise in gas prices.

Her faction in parliament supported the no-confidence vote overwhelmingly,
as did the Communist Party and the Popular Bloc, the party of parliamentary
speaker Volodymyr Lytvyn, also formerly one of the president’s allies.

Almost half the deputies of Mr Yushchenko’s party Our Ukraine chose not
to vote.

Ms Tymoshenko has made every effort to harness opposition to last week’s
gas agreement with the intention of weakening Mr Yushchenko’s party before
the elections. Under the deal, Kiev will pay $95 per 1,000 cubic metres for a
mixture of Russian and Turkmen gas, compared with $50 it was paying for
Russian gas.

Mr Yushchenko and Mr Yekhanurov described the gas deal as a victory of
Ukrainian diplomacy that ended a crisis in which Russia sharply reduced gas
supplies into the pipeline system that supplies Ukraine and many European
countries, leading to shortages across the continent for several hours on
January 2.

However, Ms Tymoshenko and others have criticised Mr Yekhanurov’s
government for agreeing to fix the rate charged to Russia for transit of its
gas to Europe for five years while Ukraine received only a six-month
guarantee on its gas import prices.

Industrial groups allied to opposition parties have also criticised the
deal. On Monday they were joined by the Industrial Union of the Donbass,
which imports gas independently from Uzbekistan and had been allied to
Mr Yushchenko. -30-
[return to index] [The Action Ukraine Report (AUR) Monitoring Service]

Maria Danilova, AP Worldstream, Kiev, Ukraine, Tue, Jan 10, 2006

KIEV – Parliament voted to fire Ukraine’s Cabinet Tuesday over a
controversial natural gas deal with Russia that nearly doubles the price
Ukraine pays for gas, but the prime minister and the justice minister said
the measure has no legal authority.

Prime Minister Yuri Yekhanurov vowed that the current Cabinet would
continue working despite the 250-50 vote by lawmakers in the Verkhovna
Rada. “People just wanted to play around; this will have no effect,”
Yekhanurov told reporters.

“The Cabinet can be formed only after new elections on the basis of a
parliamentary coalition, which must be formed by the parliament within a
month after the election,” Justice Minister Serhiy Holovaty told reporters.

Russia and Ukraine last week ended a bruising public fight over the supply
of natural gas to this ex-Soviet republic with a deal that nearly doubles
the price of gas for Ukraine. Earlier, Yekhanurov defended the deal, calling
it a “compromise” needed to prevent Ukraine from being deprived of gas

Opposition leaders complained the price for gas was too high for the
country’s industries and will eventually pinch private consumers. They also
said the deal gives Russia too much leverage over gas imports to Ukraine
and endangers Kiev’s energy security.

Political experts and analysts interviewed by The Associated Press were
divided over whether the parliament could fire Yekhanurov’s government.
Some experts said the parliament can sack only specific ministers, but not
the whole Cabinet. Others said the Cabinet could be fired.

Last year, Ukraine adopted constitutional reforms that significantly boost
the powers of the parliament and allow it to appoint the Cabinet. Yekhanurov
has argued that since the reforms came into effect on Jan. 1, the new
Cabinet can be appointed only by lawmakers elected in the March
parliamentary election.

Opposition lawmaker Nestor Shufrych, of the Social Democratic Party
(United), acknowledged that the parliament’s resolution had no legal power.
“Yes, we know that we cannot dissolve the Cabinet. … We are familiar with
the constitution,” Shufrych told reporters. “We deprived the Cabinet of the
opportunity to make decisions,” he said.
[return to index] [The Action Ukraine Report (AUR) Monitoring Service]
Send in names and e-mail addresses for the AUR distribution list.

TV 5 Kanal, Kiev, in Ukrainian 1100 gmt 10 Jan 06
BBC Monitoring Service, UK, in English, Tue January 10, 2006

KIEV- Ukrainian Prime Minister Yuriy Yekhanurov has said the gas deal
signed by Ukraine’s national oil and gas company Naftohaz Ukrayiny with
the Russian gas monopoly Gazprom on 4 January was in line with Ukraine’s
national interests. Ukraine did not lose anything, but a good price was
secured, he said. Yekhanurov was speaking in parliament, which had
demanded explanations of the agreement from the government. The
speech was broadcast live.

The following is an excerpt from the report by Ukrainian television TV 5
Kanal on 10 January:

[Parliament speaker Volodymyr Lytvyn] The floor goes to Ukrainian Prime
Minister Yuriy Ivanovych Yekhanurov. Yuriy Ivanovych, please.

[Yekhanurov] Esteemed Volodymyr Mykhaylovych [Lytvyn], esteemed
people’s deputies, esteemed colleagues!
[Passage omitted: New Year congratulations]

The issue of provision with energy resources for Ukraine, which is a country
which mostly imports them, has been topical for all these years since
independence. That is why the current government has not escaped from this
problem either. So today’s hearings in the Supreme Council are only natural.
Ukraine’s energy system has been functioning without accidents or
significant failures during the current period of maximum winter
consumption. Solvent consumers of electricity, heating and natural gas are
being supplied in full. Around 50 per cent of electricity is being produced
by nuclear plants. [Passage omitted: technical information on power

Now to the more topical gas issue. During the negotiations [with Russia],
the Ukrainian party proceeded from three principal moments.

[1] First, the need to ensure Ukraine’s demand for gas at the volume of 76bn
cu.m. in the conditions of impossibility to preserve the old system of
payments for gas, which was a barter system, in actual fact. We are
perfectly aware of the real political cost of cheap energy.
[2] Second, the need to provide for a transitional period for industry and
utilities, so that adaptation to market energy prices should be gradual.
[3] Third, full adherence to all the more than 20 documents reached between
Ukraine and the Russian Federation, between the governments of our two
countries and between companies pertaining to our relations in the gas area.
[4] Fourth, Ukraine’s obligations as a transit country regarding stable
supply of gas to European countries.
The talks were tough because the number of problems, mostly technical, was
very high. Without solving them, it was impossible to pass to cash payments.
And yes, it also tasted of politics. Unfortunately, I have to state that
certain parties both in Russia and Ukraine, on the one hand, would like to
ditch all the best things which we had in the past and, on the other hand,
ditch Ukraine’s prospects as an independent state.

Esteemed people’s deputies, as you know, the inadequate increase in tension
was triggered by Russia’s demand that new, significantly higher prices,
should be paid for gas. This was done without preliminary discussion or
consultations between the sides.

In this situation we could, as certain radical politicians are demanding
now, take a strictly defensive line, demanding full adherence to past
agreements. Yes, we were sure that we would be able to prove that we are
right in the courts, the Stockholm international court in particular. But
proceedings there take months and possibly even years.

Who would have wanted proof that we are right after several years without
gas and with ruined industry and social sector? Perhaps those who are used
to sacrificing the interests of this country and these people for the sake
of petty politicking and some imaginary benefits ahead of the election.

On the other hand, a reputation is sometimes more important than specific
results at a given time. Thanks to its constructive stance, Ukraine has
maintained and even improved its international reputation as a reliable
partner. Our position was backed by the EU. Under such conditions, giving
up talks would have meant betraying this country’s historical choice and its
civilized prospects.

Proceeding from this understanding of the situation, we on several occasions
informed the government of the Russian Federation and the leadership of the
Gazprom open joint-stock company about our vision of the negotiation

The Ukrainian president [Viktor Yushchenko], in his telegram to the
president of the Russian Federation, accepted Russia’s proposal on passing
to a market model in the gas industry. He suggested inviting international
experts in order to complete negotiations and sign a contract on gas
supplies in 2006 during the first 10 days of January. The president also
stressed that non-market methods of interaction, which would present
difficulties for the supply and transit of natural gas, would be unacceptable.

On those conditions, we continued to work within the framework of earlier
concluded intergovernmental agreements, in accordance with foreign economic
contracts. We hoped that a principal solution to the problem would be found
before the New Year. But this did not happen.

In spite of the flow of constructive proposals from the Ukrainian party and
its readiness to discuss the terms and changes in prices and tariffs on
natural gas, no proper understanding was reached. At 1000 [0800 gmt] on 1
January this year, Gazprom began to decrease pressure [in the pipe] and gas
volume supply to about 120m cu.m. per day. We were ready to work in those
tough conditions. [Passage omitted: the cabinet continued to work to
stabilize prices and decrease gas consumption]
As a result of those actions, the Russian party restored the appropriate
pressure in the Ukrainian gas transport system. Talks were resumed and
completed on 4 January with the signing of the appropriate agreement.
What do we have now?
[1] First, Ukraine has ensured a balance between gas supply and
[2] Second, a company chosen by the Russian party will supply gas to
the Ukrainian border at the price of 95 dollars per 1,000 cu.m. A
Ukrainian-Russian joint venture will be receiving gas on the border.
Ukraine will invest cash and, if somebody would like to know this,
tables and chairs, into the statutory capital of the joint venture. Ukraine
will appoint its director.
Taking into account the abundance of speculation, I want to say the
following. Generally, we should not care who will sell gas to whom until
it reaches our border. We should be interested in the price upon entry,
which is 95 dollars per 1,000 cu.m. of natural gas. This is not a bad price,
taking into consideration the European price situation. It is not our
business to know how many times gas will be resold and at which price
before it reaches our border.
[3] Third, Ukraine and Russia agreed that changes to the prices of gas
supply and gas transit will be made only if both sides give their consent.
Apart from contracts between the companies, an intergovernmental agreement
will be signed. The governments of our countries have to sign an attachment
for 2006 to the agreement between the two governments from 4 October 2001.
This attachment should provide exact conditions for the transit and supply
of gas for this year as a whole.
The Cabinet of Ministers has issued an instruction to draft this attachment,
which should be approved at the government meeting. Also, as the law on
international agreements demands, the composition of the government
delegations and appropriate instructions for the negotiations will be
approved. Proposals as to the beginning of such talks will be send to the
Russian party soon.
[4] Fourth, the price of gas for industrial facilities will depend on the
level of energy consumption. It will be differentiated.
According to the results of a preliminary analysis of the gas row, Ukraine
has reached the following: the range of sources for the gas balance of
Ukraine has been increased; the price of gas supplied to Ukraine is much
lower than the price for post-Soviet states which amounts to 110 dollars for
most of our neighbours except Belarus. The countries of eastern Europe [as
received] will be buying gas at the price of 250-270 dollars in the first

A higher price of transit of Russian gas through Ukrainian territory was
agreed. It will amount to 1.6 dollars per 1,000 cu.m. for 100 km. This is
higher than in Slovakia, and this will make it possible for Naftohaz
Ukrayiny to earn more. This money will be invested into upgrading the
existing gas transport system.

Naftohaz Ukrayiny now has time, up to five years, which is needed to prepare
the gas transport network to work in the European system of contracted

A mechanism has been set up to prevent a steep increase in prices and ensure
a gradual growth in gas price for industrial consumers to the market level
within five years. During this time, it is possible to introduce
energy-saving technologies and ensure transition to alternative fuels.

It is now possible to form, according to EU requirements, a competitive
market for gas under state control. This will stimulate reception by Ukraine
of gas from other countries and, at the same time, prevent a growth in gas
price for consumers.

The joint venture, which will be set up in Ukraine, will supply money to the
state budget.

Esteemed people’s deputies, summing up I will say that the talks were
difficult. Each party displayed toughness and persistence. The urgency of
the gas issue was so important for our society that even those who, lacking
professional knowledge, could not imagine the complications and scale of
this energy provision problem, commented on it. And certain Ukrainian
actors damaged the political and economic interests of this country by their

Finally, the signed accords are a compromise. The talks are continuing.
Necessary corrections and explanations will be made and corresponding
foreign economic contacts will be signed. I would like to assure you that
the government has been guided and will continue to be guided in its actions
exclusively by the defence of Ukraine’s national interests.

Today the president of Ukraine departed for Almaty, where he will meet the
president of the Russian Federation. The dialogue on gas supply issues will
be continued at the level of the presidents of the two countries.

[1] The Finance Ministry has found out that additional expenditure on the
upkeep of state-financed institutions will not be significant. There is no
need to revise this expenditure when the budget as a whole will be revised.
We shall settle everything by monthly allocations.

[2] Second, regarding changes to utility prices for the population, the
government believes it would not be expedient to pass a resolution on
increasing the minimum level of wholesale prices for natural gas by 25 per
cent. This resolution was adopted by the National Commission for Energy
Regulation, but it has not been registered. On this issue, the government
agrees with the Supreme Council’s [parliament] position, which was
expressed in a resolution of 20 October 2005. This way the prices for
the population will remain at the old level.

Thank you for your attention. I hope for your understanding and support.
[return to index] [The Action Ukraine Report (AUR) Monitoring Service]
Send in names and e-mail addresses for the AUR distribution list.

Press Office of President Victor Yushchenko
Kiev, Ukraine, Tuesday, December 10, 2006

KIEV – In a brief interview for reporters in Astana, [Kazakhstan]
Victor Yushchenko said he would appeal against today’s “paradoxical

and eclectic” resolution to sack the government. “Of course, I will
appeal to the Constitutional Court to prove that the voting was
unconstitutional,” he said.

The Head of State stressed that the cabinet would continue to perform their
duties. “This cabinet will be working until parliamentary elections,” he
said. “I would like to stress that they will not be acting ministers but
will work as Prime Minister and ministers. Ukraine’s political and legal
situation has not changed.”

Yushchenko added that the Verkhovna Rada “did its best to create this

chaos in Ukraine by not voting for judges of the Constitutional Court to
make the executive and judicial systems uncertain,” but assured all that,
as guarantor of the Constitution, he would not tolerate legal nihilism.

The President also said he would not change his schedule in Kazakhstan.
Apart from an inauguration ceremony of Nursultan Nazarbayev, he is

scheduled to meet with his colleagues. On January 11, Yushchenko is
going to meet with Vladimir Putin.

“After the gas row there are really many questions. We must resume our
political, economic, and governmental dialogue,” he said. -30-

FOOTNOTE: Interfax-Ukraine news agency reported that Ukrainian
President Viktor Yushchenko has also said that he does not rule out
that he may disband Parliament because of its “illegal, unconstitutional
decision” to sack the government. “I do not rule this out,” Yushchenko
told journalists in Astana on Tuesday [10 January], answering a question
from the Interfax-Ukraine news agency.

[return to index] [The Action Ukraine Report (AUR) Monitoring Service]

UNIAN, Kyiv, Ukraine, Tuesday, 10 January, 2006
KYIV, Ukraine – Commenting on today’s voting to sack the government,
Iryna Gerashchenko, Press Secretary to the President, said parliamentarians
had backed the dismissal with an eye to upcoming elections, according to
the President’s press-office. She stressed that in the past few weeks the
President and his cabinet had done their best to compromise in the
gas row not to hit Ukrainians and the national economy.
“They have secured Ukraine’s economic independence and our national
sovereignty,” she said and added that the sides had thus managed to reach
“a hard decision which could help continue the talks and work for the
diversification of the national energy market.”
Gerashchenko also noted that their actions were supported by society and
appreciated all over the world, and reminded all that the European Union had
thanked Ukraine for not making it feel “gas hunger.”
She emphasized that all patriotic political forces always united to defend
the national interests and said she was not surprised to learn that the
government had been sacked by parliamentary forces which are openly
supported by neighboring countries and which protect their own business
interests rather than the national economy.
“For many of them, it [dismissal] will give great opportunities to lobby
their interests in the energy sector,” she said.
Gerashchenko is convinced that today’s resolution would not help achieve
stability and solve difficult economic problems, particularly in the gas
“Voters will understand that, and one should not think that the people do
not understand who voted for their own pockets and who cared about
Ukraine,” she said.
Gerashchenko then added that the voting had clearly demonstrated that
many parliamentarians regarded the parliamentary republic as a tool to
blatantly blackmail the President.
She also stressed that Victor Yushchenko would not allow anyone to
destabilize the situation in Ukraine despite the intentions of certain
parliamentary forces. (

[return to index] [The Action Ukraine Report (AUR) Monitoring Service]
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Experiencing most serious political crisis in all its history

Radio Mayak, Moscow, in Russian 1500 gmt 10 Jan 06
BBC Monitoring Service, UK, in English, Tue, Jan 10, 2006

MOSCOW – The gas contract with Russia, which became the formal
pretext for the vote of no confidence in the Ukrainian government, will
not be revised, Konstantin Kosachev, chairman of the State Duma
Foreign Affairs Committee, believes.

The dismissal is more likely to be the expression of no confidence in
President Viktor Yushchenko whose popularity is plummeting,
Konstantin Kosachev has told our radio station.

[Kosachev] The dismissal of the Ukrainian government confirms the fact
that Ukraine is experiencing the most serious political crisis in all its
history. A year after the Orange Revolution, Ukraine is being led by a
president who is not supported by the majority of population.

It is being governed by a dismissed government which is not being
supported by a parliamentary majority, and finally, it is being governed by
a parliament which is busy not so much with certain strategic work as with
the parliamentary election due in March.

We can only sympathize with Ukraine in this situation. The decision by the
Supreme Council is, obviously, not so much a reaction to the concrete
results of the Russian-Ukrainian gas talks as a rejection of the Ukrainian
government’s incompetent moves in the last few months which have only
aggravated Ukraine’s own economic problems and did not allow Ukraine to
reach an agreement with Russia in a calm and normal working regime. This
could have been done several months ago.

I have no grounds to believe that these agreements may be revised. They
are based not on individuals but on intergovernmental agreements, and
international legal practice envisages that such agreements remain in force
even if a government is replaced. Any other actions by the Ukrainian side
aimed at disavowing these agreements would be at variance with
international law. -30-
[return to index] [The Action Ukraine Report (AUR) Monitoring Service]

ANALYSIS: Dr. Edilberto Segura

Director & Chief Economist, SigmaBleyzer
President, Advisory Board, The Bleyzer Foundation
The Action Ukraine Report (AUR), Number 639, Article 7
Washington, D.C., Wednesday, January 11, 2006

It seems that they are inconsistencies between the signed gas agreement
(which is given below) and statements made by officials. But this is not

This agreement and other information provided by government officials
(the PM and heads of the gas companies), and my own calculations, lead
to the following situation:

1. Rosukrenergo will get a total amount of gas of 49 billion m3 (of which
41 billion m3 will come from Central Asia (CA) and 8 billion m3 from
Russia (only about half of the maximum amount stipulated). In addition
Rosukrenergo will get 15 bn m3 for Moldova).

2. Rosukrenergo will sell to Ukraine a total of 34 bn m3 at a price of $95
th m3. Given the quoted prices ($230 th m3 for Russian and $55 th m3

for CA), about 26 bn m3 of this gas will come from CA and 8 bn m3 will
come from Russia. Rosukrenergo will keep to itself the difference of 15
bn m3 (49 bn m3 supplied to it minus 34 bn m3 provided to Ukraine) as
payment for transit fees.

3. In addition to the 34 bn m3 from the above deal, Ukraine would also

buy from CA (through a separate contract) another 22 bn m3 at an average
price of about price of $55 th m3 ($50 in 2006H1 and $60 in 2006H2).

4. The total supply to Ukraine would amount to 56 bn m3 (34 bn m3 from
the Russian deal plus 22 bn m3 directly from CA). Together with 20 bn m3
produced internally, Ukraine will have 76 bn m3 of gas for its internal use,
a figure similar to last year’s. The utilization of this gas supply is expected

to be as follows:

Households 18 bn m3
Municipal heating 15 bn m3
Power stations 5 bn m3
Industry 26 bn m3
Govt Institutions 1 bn m3
Transportation 7 bn m3
Storage 4 bn m3
Total 76 bn m3

Ukraine will have to pay the following for its 56 billion m3 of gas imports
plus the 15 billion given to Rosukrenergo for transit fees:

26 bn m3 from CA under the Russian

deal at $55/th m3 = $1.43 billion
8 bn m3 from Russia under the Russian
deal at $230/th m3 = $1.84 billion
Subtotal $3.27 billion
22 bn m3 from CA under separate
contract at $55/th m3 = $1.21 billion
Subtotal $4.48 billion
Payment to CA for 15 bn m3 of gas
given to Rosukrenergo at$55 /th m3 = $0.82 billion
Total $5.30 billion

This expense of $5.3 billion for 56 billion m3 represents a gas price of $95
/thousand m3. Therefore, the statement that Ukraine will pay $95 /th m3

at the border is right.

The total gas expense for Rosukrenergo for its gas supply will amount to
the following:

41 bn m3 at a price of $55 /th m3 = $2.05 billion
8 bn m3 at a price of $230/ th m3 = $1.84 billion
Total = $3.89 billion

To pay for these expenses, Rosukrenergo will receive payments from
Ukraine of $3.27 billion (under the Russian deal) plus 15 billion m3 of
gas. This 15 bn m3 of gas would represent revenues of $3.4 billion if
sold in Europe (that is, 15 billion m3 x $230 billion). Therefore, the
total revenue for Rosukrenergo may amount to $6.67 billion.

This will enable Rosukrenergo to pay $3.89 billion for the gas plus any
required transit fees (which are unlikely to exceed $1.0 billion at a fee

of $1.09 per 1000 m3 per 100 km for both the Ukrainian route and the
Russian route.
Rosukenergo could therefore retain about $1.8 billion for other
operating expenses and profits.

Although we do not know the terms of the agreement between Russia
and CA, the CA gas price is valid only for the year 2006. As per the
agreement below, the price of gas at the Russian-Ukrainian border of $95
per th m3 is guaranteed only for the first six months of 2006. -30-
Agreement on Settling Relations in the Gas Sector.
Moscow. Wednesday, 4 Jan 2006.

[1] The open joint-stock company Gazprom (the Russian Federation),
hereinafter called Gazprom, in the person of Board Chairman Aleksandr
B. Miller, who acts on the basis of the statutes, on the one hand,
[2] the national joint-stock company Naftohaz Ukrayiny (Ukraine),
hereinafter called Naftohaz Ukrayiny, in the person of Board Chairman
Oleksiy H. Ivchenko, who acts on the basis of the statutes, on the other
[3] and also the Rosukrenergo company (Switzerland), hereinafter called
Rosukrenergo, in the person of Executive Directors O.A. Palchykov and
K.A. Chuychenko, who act on the basis of the articles of association,
which are jointly called the Sides, have signed this agreement striving to
settle relations in the gas sector on a mutually beneficial basis and agreed
on the following:
1. To ensure transit of natural gas which belongs to Gazprom (Gazeksport
Ltd) and Rosukrenergo through Ukraine and the Russian Federation, the
Sides have agreed on the rate of payment for transit to the amount of 1.60
US dollars per 1,000 cu.m. per 100 km until 01.01.2011.
2. The Sides have agreed on the Rosukrenergo company as the supplier
of natural gas to Ukraine. From 1 January 2006 Gazprom shall not deliver
Russian natural gas to Ukraine, while Naftohaz Ukrayiny shall not export
from Ukraine the natural gas that came from the Russian Federation.
3. To sell the natural gas that came from the Russian Federation on the
Ukrainian domestic market, Naftohaz Ukrayiny and Rosukrenergo shall set
up a joint venture, within the shortest possible time but no later than 1
February 2006, whose authorized capital shall be formed by paying money
and bringing in other assets.
4. The Sides shall sign appropriate agreements and contracts (shall ensure
the signing of appropriate agreements and contracts) with the aim of
forming, starting from 1 January 2006, an annual gas balance of the
Rosukrenergo company in the following volumes:
– 41bn cu.m. of Turkmen gas to be bought from Gazeksport Ltd and
Naftohaz Ukrayiny to the amounts at their disposal;
– up to 7bn cu.m. of Uzbek gas to be bought from Gazeksport Ltd with
the aim, in particular, of swapping with gas deliveries in the
– up to 8bn cu.m. of Kazakh gas to be bought from Gazeksport Ltd with
the aim, in particular, of swapping with gas deliveries in the
– up to 17bn cu.m. of Russian gas to be bought from the open joint-stock
company Gazprom at a price to be set by a formula, proceeding from the
basic gas price (Po = 230 US dollars per 1,000 cu.m.).
– in 2006 – 34bn cu.m. of gas to be sold at the price of 95 US dollars per
1,000 cu.m. of gas which is in force in the first six months of 2006, to the
joint venture created according to Paragraph 3 of this agreement (to be sold
to Naftohaz Ukrayiny until 1 February 2006 until the creation of the joint
venture) for subsequent sale on the Ukrainian domestic market without the
right to re-export;
– from 2007 – up to 58bn cu.m. of gas to be sold to the joint venture
created according to Paragraph 3 of this agreement for subsequent sale
on the Ukrainian domestic market without the right to re-export;
– 15bn cu.m. of gas for export under joint programmes with Gazeksport
5. The rate of payment for transit and the price of natural gas which are
set in this agreement can only be changed upon the mutual consent of the


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THINKING GLOBAL: By Frederick Kempe
The Wall Street Journal, New York, NY, Mon, January 9, 2006

Russian President Vladimir Putin was surprisingly direct in a Christmas
phone call with President Bush, complaining that the U.S. was the primary
impediment to Russia’s national ambition of World Trade Organization
membership, a Russian familiar with the matter said.

A senior Bush administration official called that interpretation of the
conversation “somewhat exaggerated,” though he doesn’t quibble with the
underlying message. Russia’s leader, he conceded, has grown more
“pugnacious” as his country’s energy income and economic fortunes have
improved and his democratic practices have declined. Mr. Bush’s talks with a
leader who was once a close enough pal to invite to his Texas ranch clearly
have grown far less frequent and warm.

The larger point, and one the world largely missed during Russia’s dispute
with Ukraine last week over natural-gas prices, is that Mr. Putin has grown
more willing to flex his muscles as step by step he has re-invented the
dissolved Soviet nuclear state as a Russian energy superpower.

He has tightened his control over his country’s energy companies, set taxes
so that the state maximizes its benefit from soaring oil prices and moved to
gain more sway over energy pipelines in the region.

After Mr. Bush first met his Russian counterpart in Slovenia in June 2001,
the U.S. president famously said he looked into Mr. Putin’s eyes and saw his
soul. These days a look into those eyes is more likely to find black gold —
some 9.5 million barrels of it a day going for more than $60 a shot. Energy
is the new soul of Mr. Putin’s resurgent Russia and the primary source of
his swagger.

“Russia, instead of drawing its power from the tip of a nuclear missile, is
getting it from the end of a pipeline,” says Daniel Yergin, chairman of
U.S.-based Cambridge Energy Research Associates ( Mr.
Yergin says one can read Russia’s recent history by charting oil prices over
the last quarter century. The Soviet invasion of Afghanistan came at an oil
price peak in 1979, and Soviet decline came with historically low prices in

Mr. Yergin has concluded in a new paper that Moscow used its energy clout
last week to emerge the winner in the dispute with Ukraine. It struck a deal
that isolated Ukraine from other suppliers and extracted higher prices not
matched by increased transit fees.

As the new G-8 president for 2006, Mr. Putin has made energy security his
primary theme, given that Russia is the world’s largest natural-gas supplier
and its second largest oil producer. The conventional wisdom is that Mr.
Putin last week undermined Russia’s claim to being a highly reliable
supplier to a rising China, an already hooked Western Europe and a U.S.
looking for alternatives to Middle East oil.

But others believe last week’s shock, even if not calculated by Moscow, may
well serve as a shot across the bow of countries Mr. Putin believes don’t
show Russia enough respect. Says William F. Browder, chief executive of the
Hermitage Capital Management in Russia: “When they look for alternatives,
they’ll find Libya, Iran, Algeria, Qatar, burning coal again or nuclear
power. They may conclude: perhaps Russia isn’t such a bad partner.”

A senior State Department official says to understand Mr. Putin’s view of
his own historic role one must go back to the “time of troubles” of the
early 17th century. Mr. Putin and his ilk liken the 1990s of Mikhail
Gorbachev and Boris Yeltsin, including the official dissolution of the
Soviet Union in 1991, to the national nadir when the dynasty that founded
the Russian state ended with chaos and a Polish king ruled Moscow.

Mr. Putin sees himself as a modern-day Romanov ending Russian decline and
rebuilding national stability and prestige. The problem is that Mr. Putin’s
view of power is frozen in a 19th century world outlook that dictates that
Russia must have strongly centralized authority and can be strong only if
its neighbors are subordinated politically and economically.

Thus, he views the U.S. and Europe as imperial rivals that are reducing
Russia’s realm by supporting democratic revolutions in Ukraine and Georgia
and drawing those former Soviet states closer to a West that has already
drawn the Kremlin’s former Baltic states and much of the former Warsaw
Pact into NATO and the European Union.

Mr. Putin’s resurgent Russia leaves the West with a dilemma. It needs
Russia’s energy and support on issues ranging from Iranian nuclear
proliferation to global terrorism. Yet the West must safeguard the region’s
democratic gains and find ways to counter Mr. Putin’s antidemocratic
impetus that most recently produced legislation that essentially would shut
down independent nongovernmental institutions.

Much of Mr. Putin’s energy strategy has been cold calculation and the rest
has grown out of rising prices.

Mr. Putin began tightening control over his country’s resources by
redominating and then dismembering Russia’s most important private oil
company, Yukos, following the arrest of oil tycoon Mikhail Khordokovsky.
The Kremlin cemented majority ownership of Gazprom, the most important
instrument of its energy power, and ensured that the company — and not a
foreign oil giant– swallowed the Sibneft oil company in September of last

In addition, Mr. Putin’s allies have built up Rosneft as a second Russian
energy giant partly by orchestrating its acquisition of Yukos’s most
valuable assets. When Yukos tried to block financing from Western banks
in a Texas court, Gazprom’s planned bid fell apart. But Rosneft was able
to come to the rescue, thanks to hastily arranged loans from state-run
Russian banks as well as a deal to get paid up front for planned crude
sales to China.

Last year’s oil price spike played into Mr. Putin’s hands as existing tax
rules gave the state the lion’s share of revenue over $25 a barrel, yielding
a budget surplus, $174 billion in hard-currency reserves and $47 billion for
a fund that is earmarked for social programs and emergencies such as flood
relief. “Russia has gone from being a poor country to being a rich country
in just six years,” says Mr. Browder.

There are holes in the Putin plan. World powers are never made of energy
resources alone. Russia companies haven’t invested sufficiently in new
exploration, and Russian oil and gas production is beginning to flatten out
and decline after several years of growth. Someday, alternative energy
sources or price declines could prick Russian power.

Yet for now the West will have to deal with a pumped-up, increasingly
confident Mr. Putin who will defend limits on Russian democracy and
demand a larger voice regionally and globally. -30-
Write to Frederick Kempe at with your thoughts.
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EDITORIAL: The Moscow Times
Moscow, Russia, Tue, Jan 10, 2006. Issue 3327. Page 9.

Channel One television produced a stunning piece of political theater on
Jan. 4, the day the deal was signed on the delivery of natural gas to

President Vladimir Putin was shown being briefed at his Novo-Ogaryovo
residence by Gazprom head Alexei Miller and Industry and Energy Minister
Viktor Khristenko. None of the three men could have been described as
looking well rested or terribly happy, which was understandable given the
pounding they had come under after so proudly cutting the flow of gas on
Jan. 1 to Ukraine and, as it turned out, to much of Europe.

But in front of the cameras they spoke only of success. The words
“European prices” and “European principles” served as a sort of refrain.

Putin said it was important that Russia’s price for its gas was “recognized
as just.” More important, though, was that Russia’s relations with Ukraine
had taken on a new quality. “They are transparent, market-based relations
between partners,” he said.

For Western Europe, the deal created “absolutely new and stable conditions”
for the delivery of Russian gas, Putin said.

The news in Ukraine sounded quite different. “Russia agreed to our
conditions because we had right on our side,” Naftogaz Ukrainy head Alexei
Ivchenko said, according to the Ukrainskaya Pravda web site.

The Western press took the middle ground. As The Washington Post put it,
“Russia and Ukraine struck a face-saving and complex deal that allowed both
sides to say they secured the price they wanted for natural gas.”

But whatever the deal was, it was not “transparent” and it did not create
“stable conditions” for the delivery of Russian gas.

Under the deal, all gas delivered to Ukraine, and some of the gas delivered
to Europe, will be handled by Rosukrenergo, a Swiss-registered trading
company with a dubious reputation that is half-owned by Gazprom. The
other half is held by Raiffeisen Bank on behalf of a group of investors
whose identities have not been disclosed.

Rosukrenergo, which for the past year handled the sale of Turkmen gas to
Ukraine, has been accused of having ties to organized crime. True or not,
and the company denies the allegations, its nontransparent structure makes
it difficult to determine who is profiting from the sales of billions of
dollars’ worth of gas.

Also, it appears that the price that Ukraine will pay for natural gas has
been set only for the next six months, not for five years as originally
billed. What happens when July 1 rolls around?

The deal raises many questions. The only one that it seems to answer is that
Europe can no longer count on Russia as a reliable energy supplier.
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COMMENTARY: By Jan Kalicki and David Goldwyn
Financial Times, London, United Kingdom, Mon, January 9 2006

The most serious challenge posed by the energy crisis is not high oil
prices, low inventories or the fact that consumers are using oil much faster
than we find new resources. It is the damage oil dependence poses to
international security. Unless we integrate energy and foreign policy and
treat energy security as a priority, we will suffer economic pain and a more
dangerous world.

Even if the US and the European Union had a focused technology strategy,
greater incentives for hybrid cars and alternative fuels and more aggressive
fuel economy standards, we could not reduce the world’s dependence on oil
from Saudi Arabia, the United Arab Emirates, Iran, Venezuela and Russia for
at least two decades.

Worse still, even assuming progress in efficiency, the world will need to
extract almost twice the volume of oil we use today, with ever more of those
resources coming from the Organisation of the Petroleum Exporting Countries.

This challenge means the US, our allies and big consumers such as China and
India will compete for access to countries that allow foreign investment in
their energy sectors and will compete for favour with those such as Russia
and Venezuela that are limiting foreign development and using oil to expand
political influence.

Unless we change our foreign policy course, for the next two decades we will
enrich Opec and producers that maintain high prices and weaken the ability
of the US or allies to influence these countries.

This transfer of wealth will also deepen the hold of undemocratic leaders in
oil producing nations, further enable the repression and underdevelopment
that fosters terrorism, and finance nuclear proliferation in Iran and
weapons proliferation in Africa. Consumers do not bite the hand that feeds
them: the Middle East is feeding Asia its oil and gas, Russia is feeding
Europe natural gas and Venezuela is subsidising oil and products in Latin
America and the Caribbean.

US influence will continue to wane as our allies depend on our adversaries
and competitors for energy. Russia’s dispute with Ukraine, which led to
reduced gas supplies to Europe, underlines the need for a collective energy
security strategy that moves countries away from coercion to collaboration.

The US and other Organisation for Economic Co-operation and Development
members must revive the vision and courage of 1974 and restore control of
our strategic future.

[1] First, we must press for a new producer-consumer compact, in which
producers agree to increase capacity through shared investment from
consuming nations and consumers increase efficiency of energy use.

This compact should be a top priority of our energy diplomacy, offering a
realistic alternative to the dead ends of producer-consumer confrontation
and the current spiral of increasing prices and consumption.

[2] Second, we must expand the um-brella of collective energy security
by strengthening multilateral technology co-operation in efficiency and
conservation and, more immediately, by opening access to strategic reserves
and the OECD’s co-ordinated Emergency Response System to China and
India so their sense of energy insecurity does not convert them into
adversaries. China is seeking to lock up long-term contracts rather than rely
on the market system created by the west because it has no safety net. We
need to pull it into the market system, not lock it out.

[3] Third, we must align ourselves with reform-oriented opinion leaders
who support transparency and political and economic opportunity in the oil
producing nations so we do not lose the hearts and minds of their citizens.
Fourth, we must begin to build our strategic reserves to keep up with
consumption. Fifth, we must lead by domestic example. The US should
adopt a national technology strategy focused on transport, rather than the
patronage-driven hodge-podge of current programmes.

The objective is to increase energy security and interdependence. It should
be recognised, however, that certain governments will hold out for the
current state of affairs. For those, it may prove necessary to use our power
as consumers to press them to open their markets to energy trade and
investment, as we open ours for manufacturing and services.

Oil prices are high because most producers do not invest to keep up with
demand and refuse to let the free market operate by allowing investment in
to produce the supply the world demands. If the US and its partners must
discriminate against energy imports from nations that are closed to
international investment, let consumers pay a “freedom tariff” that will be
invested in technologies to replace the use of petrol to power cars.

There is a forum to advance such a strategy in 2006 and to ensure that
Russia is a partner, not a pitfall, in achieving it: the Group of Eight
industrial nations plans to make energy security a top priority. By leading
with these new initiatives the US can increase energy supply, manage demand,
lower prices, restore its international leverage and manage its way through
the next two decades, until the day when hydrocarbons do not drive our
foreign policies as well as our cars.
Jan Kalicki is former counsellor to the US Department of Commerce;
David Goldwyn is former assistant secretary of energy for international
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Be A Vice-President In Charge Of The Continuing Orange Revolution

OP-ED: By Rajan Menon and Oles M. Smolansky
Los Angeles Times, Los Angeles, California, Sun, January 8, 2006

RUSSIA AND Ukraine have ended their spat over natural gas prices.
Ukraine will pay more, but much less than Russia originally demanded.
That’s the good news.

The bad news is that the outcome owed little to Western diplomacy.
Ukraine, a budding democracy, deserves Western support. Europe
squawked when Russia cut its gas supplies, but that hardly amounted to
a coherent policy of backing Ukraine against what was a huge ­albeit
spectacularly inept ­Russian power play.

When the quarrel began last week, it looked like a huge mismatch. Gazprom,
the Russian energy giant, had slapped its 400%-plus natural gas price hike
on Ukraine just as winter gained hold and Ukrainian President Viktor
Yushchenko faced a financial crisis. Dependent on Russia for 30% of its
natural gas, Kiev seemed certain to cave.

The Kremlin’s hard-line approach had two objectives. It covets Ukraine’s
natural gas pipeline system (Gazprom wants a 51% share), and it seeks to
undercut Kiev’s pro-Western policies so Ukraine will remain in Russia’s
sphere of influence. Short of that, Russian President Vladimir V. Putin
wanted to demonstrate the steep costs of spurning Moscow to dance with
the West.

Ukraine was not without countermoves, among them a declaration of
sovereignty over the waters of the Kerch Strait that would allow
third-party access (read: NATO ships) to the Sea of Azov, and a threat to
leave the Russian-led Commonwealth of Independent States.

When Yushchenko refused to back down, Russia, realizing that it would look
foolish for making empty threats, turned off the spigots and dragged Europe
into the dispute, which proved to be Moscow’s undoing. Europe relies on
Russia for about one-third of its natural gas, and most of it is delivered
through Ukrainian pipelines.

The biggest loser was Gazprom, whose role as a stalking horse for Kremlin
intentions became evident. The nominally private company insisted that
market forces dictated its price increase for Ukraine, but closer
inspection revealed that attitudes toward Russia were a better indicator.
For instance, Belarus, a Putin ally, pays one-fourth the price that Gazprom
demanded from Ukraine.

The Kremlin was tarnished as well. It made a mockery of Gazprom’s
pretensions of independence when Putin essentially took over the
negotiations for the Russian side. And its demand that Ukraine absorb an
all-at-once price increase made it look like an extortionist.

Worse, the Europeans began wondering whether Russia was a reliable source
of energy. And Gazprom’s cavalier disregard for the pricing accord it had
signed with Ukraine in 2004 raised questions about the state of reform in
Putin’s Russia, specifically its attitude toward the sanctity of contracts.

The European Union, then, rescued Ukraine not out of magnanimity or
principle but because it didn’t want a cold winter. Germany, which is not
given to criticizing Moscow, called on Russia to “act responsibly.” Other
EU states chimed in as well.

Ukraine faces more price increases, which will force it to make some
painful economic choices. Moscow will undoubtedly seek political advantage
and a larger footprint in Ukraine in exchange for any concessions to smooth
the transition.

But this cloud could spark a much-needed transformation of Ukraine’s
inefficient Soviet-era industries. And that’s something Kiev must do if its
plans to integrate with the West and join the EU are anything more than

There is much the West should do to help Ukraine as the most important
democratic state to emerge from the debris of the Soviet Union reforms its
economy and tries to lessen its dependence on Russia. Stoking anti-Russian
sentiments or making false promises is not what’s needed. Instead, Kiev
needs sustained and multifaceted engagement from the West, despite
Russian complaints of “interference.”

In this latest flap, Moscow has again shown that it will use its muscle to
try to shape its neighbors’ politics and foreign policy. Ukraine is roughly
the size of France ­ too important to concede to Russia as a client state.

Russia wants more trade, more foreign investment, a voice on major
international issues and membership in the World Trade Organization, and
the West should exploit these ambitions to shape the Moscow-Kiev
relationship. -30-
Rajan Menon is Monroe J. Rathbone professor of international relations
at Lehigh University and a fellow with the New America Foundation.
Oles M. Smolansky is university professor of international relations
at Lehigh University.
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If you are receiving more than one copy of the AUR please contact us.
Paul Robinson says that Russia was only doing what the EU
had demanded when it increased its gas prices this week

COVER STORY: By Paul Robinson, The Spectator magazine online
London, United Kingdom, Saturday, January 7, 2006

I don’t believe that I can be alone in having spent a Russian or Ukrainian
winter with the windows of my room wide open. Many buildings in that part
of the world are dreadfully overheated, for the simple reason that energy
is so cheap. Soon, however, Ukrainians will have to learn to close their
windows. Until this week, the Russian gas company Gazprom charged
Ukrainian consumers $50 for every 1,000 cubic metres of gas they used.

On Sunday Gazprom demanded that they pay $230. The Ukrainians’ first
response was to refuse, and the Russians turned off the gas. The choice, it
seemed, was expensive fuel, or no fuel at all. On Wednesday, the Ukraine
agreed to pay $95 per 1,000 cubic metres for a mixture of Gazprom supply
and cheaper gas from Central Asia. Gazprom has, for the moment, said it is

What’s going on? With the collapse of Soviet military and economic might,
Russia was left with very few means with which to influence the world
around it. Now rising energy prices have handed Moscow a new weapon.

Russia has 30 per cent of the world’s natural gas deposits and 10 per cent
of the world’s oil. Oil and gas production in the rest of Europe is declining,
and within a few years the European Union will import about half of all its gas
from Russia. This gives Russia great leverage over its neighbours, and the
Russian president Vladimir Putin is showing clear willingness to use that

We Brits love an underdog. As Robert Baden-Powell harrumphed in his
classic Scouting for Boys, ‘If you see a big bully going for a small weak
boy, you stop him because it is not “fair play”.’ Gazprom’s price hike
provoked great howls of indignation in some circles of the British press,
particularly as Russia has this week taken over the rotating chairmanship
of the G8, and the issue will certainly embarrass Western leaders.

According to the Daily Telegraph, ‘The methods of gangsterism and
blackmail now being used by Gazprom are reminiscent of the Soviet era.
. . . The West has to tell Russia that, plainly and simply, its conduct is
unacceptable if it wishes to remain part of the club of civilised nations.’
Unfortunately for those spinning this simplistic tale of bully and bullied,
Gazprom’s ‘unacceptable conduct’ is actually something we have been
requiring of it.

For in raising the prices they charge for gas in Eastern Europe, the
Russians are merely going part way towards meeting demands made by
the European Union over several years.

The initial increase in the gas price proposed by Gazprom from $50 to
$230 per 1,000 cubic metres was certainly a large one, but it is, after all,
what consumers in Western countries such as Germany are charged,
whereas $50 is below cost price, meaning that Gazprom made a loss
by selling gas at that rate.

Gazprom is only notionally an independent company; in practice
it is an arm of the Russian state, which owns 51 per cent of the stock, and
the state is prepared to take a loss in some circumstances for political
advantage bribing potential allies, keeping Russian voters’ energy bills
low, and subsidising domestic industry, for instance.

Accordingly, Gazprom has been selling its gas at $50, or even less, to
consumers throughout the Commonwealth of Independent States (CIS) ever
since the collapse of the Soviet Union. As Aleksandr Ryazanov, deputy
director of Gazprom’s board of directors has noted, $50 ‘doesn’t even
cover our real costs for producing and transporting gas to CIS countries’.

Now you might imagine that it is entirely Gazprom’s business if it wants to
make a loss on some of its deals; but not so in the eyes of the
ever-meddling European Union, which for years has been demanding that
Russian companies stop subsidising energy prices and start charging market
rates. In the oil sector, this has largely happened. In the gas and
electricity sectors, it has not. Gazprom and the Russian electricity giant
UES have, therefore, long been in the Eurocrats’ sights.

In October 2000 the EU and Russia started a series of bilateral meetings
known as the ‘EU Russia Energy Dialogue’. On the European side, the aim
of the dialogue is to reform the monopoly system in the Russian gas and
electricity markets, open up those markets to EU investors, enhance
environmental protection and secure Europe’s energy supply.

On the Russian side, the aim is to gain long-term contracts for Russian
energy exports, attract European investment and gain unrestricted access
for Russia’s exports into the EU. Parallel to the energy dialogue,
negotiations took place between the EU and Russia regarding Russia’s
entry into the World Trade Organisation (WTO). Much to the Russians’
annoyance, the EU linked the two, demanding that Russia liberalise its
energy prices as a condition of European support for its WTO

The reason the EU dislikes the low prices charged by Gazprom to CIS
members is that these are considered an unfair subsidy to CIS industries,
which gives them a competitive advantage over European companies.

This is of particular concern in some sectors such as metals and
fertilisers, where CIS exporters have been able to keep costs low through
subsidised energy, and then harm European competitors. For instance, the
collapse of communism led to a dramatic fall in domestic Russian demand for
nitrogen fertilisers. The Russian fertiliser industry responded by what has
been called an ‘aggressive export dumping campaign’ in the EU. In
accordance with its free-market principles, therefore, the EU has stated
that Russian energy subsidies are incompatible with free trade and must go.

In addition, the EU is in the process of liberalising its own energy
industry. The Russian habit of signing long-term contracts with different
European countries at differing fixed rates is incompatible with the aim of
producing an EU-wide free market in energy. ‘Marketisation’ of the Russian
energy system is, therefore, an important European goal.

Aware of the inefficiencies and waste caused by its policies (open windows
in winter, for instance), the Russian government in April 2003 laid out
objectives for achieving more efficient energy use. This strategy requires
marketisation of the energy sector, including liberalisation of prices
(albeit gradually to avoid excessive shock) and raising the costs of energy
consumption in order to reduce waste and increase exports of surplus

On the environmental side, the EU pressured Russia long, hard and
ultimately successfully to ratify the Kyoto accord. This requires a
reduction in carbon emissions, and so adds further incentives to reduce
consumption of oil and gas by means of raising prices. Consequently, Russia
became aware of the advantages of higher prices, and in May 2004 reached a
compromise agreement with the Europeans. The EU agreed to support Russia’s
WTO accession, in return for which Russia promised to double its domestic
gas prices by 2010.

Given all this, Gazprom’s decision to charge market prices to Ukraine is,
on the surface, one for which the EU should be congratulating it. It
represents at least a small step in a general Russian policy towards
liberalisation which has been slowly gaining pace over the past five years,
in part due to EU pressure and in part due to the needs of the Russian

One of the problems of subsidies is that they distort economic
behaviour, creating wastefulness and inefficiencies in the allocation of
resources. Ukraine is not the world’s sixth largest consumer of natural gas
because its industry requires such enormous consumption, but because its
subsidised prices make it indifferent to energy-saving. Paying more for its
energy might actually do it some good.

In short, the increase in gas prices is fully in keeping with the West’s
desire to complete the process of creating a genuine market economy in
Russia, Ukraine and the other countries of the CIS, as well as progressing
towards fulfilling the environmental demands of the Kyoto accord. It is an
entirely welcome gesture from the perspective of any free-market economist,
not to mention any environmentalist.

Economics cannot be the only reason Gazprom has acted the way it has. The
company has, after all, chosen to increase its charges to most former
Soviet countries by much less than it was threatening to increase those to
Ukraine. Gazprom’s charges to Georgia are increasing from $60 per 1,000
cubic metres to $110. Similarly Armenia will now pay $110, Moldova $160,
and the three Baltic states $120 125. Until Wednesday’s last-minute deal it
seemed as though Ukraine had been singled out for particular punishment.

Perhaps the $230 was more bargaining chip than ultimatum, but it is hard
not to see Moscow’s move as political a reaction to the perceived
anti-Russian policies of the current Ukrainian administration.

Aleksandr Lukashenko, President of Belarus and Russia’s close ally,
recently signed a new deal guaranteeing his country continued gas supplies
at $47 per 1,000 cubic metres, and gloated about this at the end of last

His deal, he said, was a ‘reward for loyalty’. Indeed.

Putin seems to regard the key to Russia’s resurrection as being the
recreation of a powerful central state. Weak government has been a
perpetual problem in Russian history, and has all too often brought
economic and social disintegration. For this reason Putin has sought to
bring the most important economic assets of the country the oil and gas
industries back under the sway of the state. The renationalisation of
Mikhail Khodorkovsky’s Yukos oil company can be seen in this light. Now,
having more or less completed this process, the President is flexing his
new-found muscles on the international stage.

It is this which causes the current indignation. But in truth, all major
nations provide aid and subsidies to their allies, and seek to coerce or
punish others. As Eric Kraus, chief strategist at the Sovlink Securities
brokerage firm in Moscow, comments, ‘Russia does not have to subsidise
countries which are overtly hostile to Russia. The Americans or the French
or the Germans can give foreign aid to some countries and not to others.
They heavily subsidise Egypt; they don’t subsidise Syria.

Does this give Syria the right to complain of unfairness? Russia can choose
to subsidise for geopolitical reasons countries of her choosing. It’s a
sovereign right.’ Putin’s policy certainly represents a very crude pursuit
of national interest, implemented unilaterally and with little regard for
international opinion. But as such it is not so very different from the
sort of policies pursued by other states, including our own.

Furthermore, the marketisation of energy policy which it involves is
entirely in keeping with the demands that European states have been
making of Russia for several years. While one may sympathise with the
Ukrainians who are having to shut their windows, there is in reality very
little to be indignant about. -30-
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Send in a letter-to-the-editor today. Let us hear from you.
The Ukraine crisis is a post-Soviet tale of Jekyll and Hyde. By day,
good Dr. Putin tries to remake Russia as a modern country. By night…

By Michael Meyer, Newsweek, International Edition
New York, New York, Edition, January 16, 2006

Power is a double-edged weapon, Vladimir Putin once told NEWSWEEK,
likening it to a razor in the hands of a drunk. Wield it clumsily and you’ll
be hurt. Lately, Putin himself has played the drunk. And he’s bleeding. The
crisis in Ukraine is only the latest in a series of self-inflicted wounds,
ranging from the bungled takedown of the Yukos oil company to last year’s
disastrous meddling in Kiev’s Orange Revolution.

With Moscow assuming leadership of the G8­a long-sought validation of
Russia’s standing in the Western world ­the Kremlin might have been on best
behavior. But no. By cutting Europe’s gas supplies, only to see the tactic
backfire, Putin & Co. once again showed themselves to be “the gang that
can’t shoot straight,” as Stephen Sestanovich, a former U.S. ambassador
to Russia, bluntly puts it.

It’s puzzling. Like him or loathe him, Russia’s president is anything but a
klutz. Critics accuse him of rolling back democracy and seeking to
resurrect an empire of Soviet Lite. But they rarely deny his
accomplishments. Almost singlehandedly, he imposed order on the chaos
of the post-Yeltsin years.

New tax laws have filled the state treasury; the economy is booming. After
leaving the KGB, Putin even wrote a part-time grad-school thesis on how
Russia could use its energy resources to regain its global sway. As
president, he’s done just that.

So the question: how does he so often get things so wrong? The
explanation lies in the nature of his regime, a self-defeating coupling of
arrogance with paranoia, power with weakness.

Begin with the Ukraine debacle. Cliff Kupchan at the Eurasia Group in
Washington describes it as a sort of post-Soviet tale of Jekyll and Hyde.
By day, the good Dr. Putin seeks to remake Russia as a modern European
country. Hence, he intends to clean up Gazprom and open it to foreign
investors. (Never mind that, along the way, he’ll enrich Kremlin cronies
who’ll get stakes cheap and later sell out for big money.) He promises that
Russia can be counted on as a secure, reliable energy supplier, in contrast
to the uncertain Middle East. But then night falls.

Almost despite himself, Putin succumbs to dark inner urgings: a desire to
punish Ukraine, perhaps a determination to show Europe (and others) that
a resurgent Russia can no longer be taken for granted. “They are drunk on
petrodollars,” says Kupchan. “That inebriation caused them to miscalculate.”

And what a miscalculation. Not even during the cold war did Russia resort
to using energy as a weapon. It was the ultimate un-European and antimodern
act, undermining Russia’s progress on all other fronts.

Closer to home, the same dynamic is at work. The story of how Putin rebuilt
the Kremlin’s power is familiar. He is a Russian Pinochet, or Marcos,
tolerant of divergent views as long as they do not intrude on politics. Yet
within the Kremlin itself the picture is weakness, not strength, as
factions compete for money and power in an elite bureaucratic free-for-all
that checks the president’s latitude. Paranoia and isolation rule the
Kremlin roost, says Pavel Felgenhauer, a prominent Moscow political

Surrounded by spinmeisters, Felgenhauer argues, Putin trusts no one
fully­ neither their motives nor the information they bring him. Thus
he delays decisions until forced by events, and then he often overreacts.

Frequently the result is some variation on Ukraine­a nightmare of
unforeseen and ugly consequences. Think of the mishandled Beslan and
Moscow-theater hostage crises, with their needless civilian casualties, or
the ham-handed meddling in Kiev’s “colored revolution” ­which Kremlin
extremists fear will spread to such neighbors as Belarus if not Russia
itself, abetted by Western “spies.”

A potentially even bigger mess is brewing to the south, unnoticed by most
Russians­let alone the outside world. Contrary to Moscow’s story line, its
brutal war in Chechnya is spreading. For years Putin and his men indulged a
fantasy that the fighting was the work of a small minority of Islamic
“terrorists” who could sooner or later be crushed by raw military power.
Now a virtual civil war rages, with Chechens preying on one another, led by
Kremlin satrap Ramzan Kadyrov and his personal army of mercenaries
specializing in kidnapping, extortion and murder.

Fearing Islamic insurgencies elsewhere in the region, Moscow has cracked
down on the population at large, closing mosques and detaining hundreds
(if not thousands) of suspected troublemakers while condoning corruption
and abuse by local security forces. The upshot, says Rajan Menon, a Russia
expert at Lehigh University, is to alienate the populace still further,
playing into the hands of extremists and fanning the fires of a war throughout
the North Caucasus.

Who dares speak truth to Putin’s power? Precious few. One who did,
economic adviser Andrei Illarionov, quit just last week, all but throwing
his arms into the air over the Ukraine gambit. To NEWSWEEK, Putin once
described himself as “very cautious, very careful.” And so he is­ except
when he’s not. -30-
[return to index] [The Action Ukraine Report (AUR) Monitoring Service]
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Last week’s reduction in gas supplies to Europe threw Gazprom, the
scariest company in the world, into the limelight. Sylvia Pfeifer looks
at the energy giant and the political influences on it

By Sylvia Pfeifer, Telegraph, London, UK, Sunday, January 8, 2006

With about a third of the world’s gas reserves, it is to gas what Saudi
Arabia is to oil. Gazprom, the Russian state-owned energy giant, is the
country’s largest company, with nearly 300,000 employees. It produces a
third of the world’s supply of natural gas and supplies about a quarter of
Europe’s needs.

Over the past 10 days Gazprom has found itself at the centre of a
geopolitical game being played out across Europe.

Last weekend’s decision by Russia to cut off deliveries of its gas to
Ukraine led to supplies in European states falling by up to a third.

The move, after Ukraine refused to accept a fourfold increase in prices,
was widely seen as a politically motivated attempt by Vladimir Putin, the
Russian president, to take his revenge on Ukraine for the triumph of Viktor
Yushchenko, its pro-Western president, in the Orange revolution.

“You couldn’t have such a big discount [in gas prices] unless there was huge
political will for it to continue. The reality is that Ukraine is drifting
towards the European Union, so why would Russia continue to support such
a steep discount?” says one long-term Russia watcher, adding that it was
simply a case of political and commercial agendas coming together.

A full-blown supply crisis was averted on Wednesday after the two countries
reached a compromise deal that allowed both sides to claim victory.

For Gazprom, however, the dispute has only highlighted the difficult
balancing act it is trying to master. Under Alexey Miller, the chief
executive, the company has tried to turn itself into one of the world’s
leading energy corporations alongside ExxonMobil, the US giant, and
Britain’s BP. Its purchase in the autumn of 73 per cent of Sibneft, the oil
giant, from Roman Abramovich, the billionaire tycoon and owner of Chelsea
Football Club, for $13.1bn (£7.5bn) has also turned it into an important
force in oil.

Like other energy companies, Gazprom has benefited from soaring
commodity prices which helped it report record earnings and cashflow
last year.

Miller’s ambitions for Gazprom received a further significant boost at the
start of this month with the long-awaited opening of the company’s locally
traded shares to foreign investors. Hitherto, foreign investors have been
restricted to owning securities called American Depository Shares, quoted in
London and New York. These confer rights over about a fifth of Gazprom’s
equity and currently trade at a significant premium to ordinary Russian
shares, which are quoted in St Petersburg. However, even after
liberalisation, the Kremlin will keep its 51pc stake.

It also opens the door for Gazprom’s inclusion on Morgan Stanley’s MSCI
Emerging Markets index, which, in turn, will open the stock to a mass of
institutional investors wielding an estimated $3 trillion. With a market
capitalisation of more than $150bn (£87bn), Gazprom stands to become the
most heavily weighted company in the index, and some analysts believe its
market capitalisation could double to as much as $300bn.

Fund managers say the appetite for the shares among foreign investors will
be strong but, as last week’s dispute with Ukraine only underlines,
questions remain over how Gazprom can become one of the world’s leading
energy companies with a share price to match if it is just an arm of the
Kremlin’s foreign policy.

Over the past 18 months Putin has reasserted the Kremlin’s control over the
country’s strategic natural resources away from the power of the oligarchs.
He has also made it clear that he intends to use Russia’s immense natural
resources to help him increase the country’s leverage in its relations with
the West. As last week’s dispute with Ukraine showed, Gazprom is the ideal
vehicle to help him do that.

Long regarded as a state within a state, the company is responsible for 8
per cent of Russia’s gross domestic product and provides about 20 per cent
of earnings to the federal budget. Given the company’s importance to Russia,
Miller is likely to have to continue his difficult balancing act of trying
to reconcile the interests of the state and that of his institutional

Last week, long-term Russia watchers said that irrespective of the Kremlin’s
control, foreign investors and analysts should not underestimate Gazprom. “I
don’t think people realise just how powerful an energy company Gazprom is,”
says Stephen O’Sullivan, an analyst at United Financial Group in Moscow.

Many also believe that Gazprom is simply too attractive an investment
opportunity to ignore. Investors shouldn’t expect to receive any sizeable
dividends in the near future – the current policy effectively limits the
payout to 17.5 per cent of net earnings – but its shares are cheap compared
with those of Western rivals.

“It’s an enormously profitable business and you can buy its shares at a 90
per cent discount to its Western counterparts,” says Bill Browder, the chief
executive of Hermitage Capital Management, whose largest investment in
Russia is in Gazprom. He also makes the point that Gazprom’s new pricing
policy towards Ukraine ultimately will benefit stockholders.

“For the past 15 years, Ukraine has been receiving a gift of between $1bn
and $4bn a year from Gazprom. The company has had to subsidise the
Russian population and former Soviet republics. Other countries, such as
Poland, are now paying more [for their gas]. There is simply no longer a
political reason to subsidise these countries,” Browder says.

He concedes that investors can’t expect Anglo-Saxon-style corporate
governance but he insists that there is a move towards greater transparency.
“It was truly a disastrous company in the late 1990s. Although it is still
far from perfect, it is now more and more becoming a regular company. You
can’t expect Western-style Anglo-Saxon practices but the trend is clearly

Much of the credit for the improvement goes to Miller, who has helped to
correct some of the mistakes of the previous regime, led by Rem Vyakhirev,
who was chief executive from 1992 until 2001, when Putin fired him.

Under Vyakhirev the company lost market share and the volume of production
fell. It lost an estimated $5bn through asset stripping, often to companies
owned by relatives of the senior management.

Under Miller production is growing again and the company is opening up new
markets. It is in the midst of a programme that will redraw the energy map
of Europe by building underwater pipelines in the Black and Baltic Seas,
extending its reach and the scale of its sales to the West.

Gazprom recently started construction of the North European Gas Pipeline
which stretches 1,200km across the floor of the Baltic Sea to Western

The pipeline – which is controlled by Gazprom through its 51 per cent stake,
but is jointly owned by the German energy companies BASF and E.ON – has
raised considerable controversy in recent months. Last year the project
appointed former German chancellor Gerhard Schröder as its chairman – just
weeks after he signed the pipeline agreement with Russia, soon before he was
ousted from office following September’s general election in Germany.

Importantly for Gazprom, once completed, the pipeline will reduce its
dependence on its neighbours, including Ukraine.

Aside from its programme of pipelines, Gazprom has also invited foreign oil
companies to pitch for participation in a consortium that should be ready by
April to start developing the strategically crucial Shtokman field, 555km
north east of Murmansk on the Kola Peninsula. It is set to become the
world’s largest offshore gas field with 3.2 trillion cubic metres of gas
contained in reservoirs 2km below the seabed.

Gas from the field is set to be pumped through four pipelines to liquefied
natural gas (LNG) processing plants near Murmansk. From there much
of the LNG is to be shipped in giant tankers to North American markets.

Nevertheless, despite such ambitious plans, Gazprom remains inefficiently
managed, overstaffed and with divisions far outside its core business. These
include Gazprom-Media, NTV TV, two airports, the Rigas porcelain
company and a chicken farm.

Browder says: “Miller has been successful at containing the asset leakage
from the balance sheet. Now he needs to cut costs and make the company
efficient. If you use the analogy of Miller being an emergency room doctor,
then he’s stabilised the patient but the question now is, can the patient
get back to optimal health?”

Most analysts believe Miller is keen to shed non-core assets such as the
media operations. “These are political, not financial assets,” says one
Russian banker. “Miller wants to build a global energy company.”

New institutional investors who come in on the back of the share
liberalisation will undoubtedly exert pressure on Gazprom to become more
transparent but ultimately, the success of Miller’s ambition still lies in
the hands of the president. -30-
[return to index] [The Action Ukraine Report (AUR) Monitoring Service]
With Putin flexing his muscle in the energy market, investors should think
twice before taking a stake in state-controlled Rosneft, writes Conal Walsh

By Conal Walsh, The Observer, London, UK, Sunday January 8, 2006

LONDON – Sergei Bogdanchikov, president of Rosneft, laughed when The
Observer asked whether his Kremlin-controlled company was an example
of ‘state capitalism’. ‘I’m not a politician,’ he replied. ‘I don’t really
care what kind of capitalism it is.’

That was 15 months ago, and as Rosneft prepares for a London and Moscow
flotation, Western investors don’t seem to care either. Russia’s biggest oil
firm plans to make around a fifth of its stock available at IPO, and to
raise up to $20bn (£11.4bn). It will probably succeed – even though the
Russian government will retain a majority shareholding.

It may seem ironic that the London market is being asked to finance one
Kremlin-run company just as another – gas giant Gazprom – has been engaged
in an alarming dispute over energy supplies to neighbouring Ukraine that
threatened to disrupt Western Europe’s own supplies. But high oil and gas
prices have created huge investor appetite for Russian energy stocks.

The Russian government is keen to capitalise on this demand. As well as
planning the Rosneft float, the president, Vladimir Putin, allowed Gazprom
to make 49 per cent of its stock available to foreign investors. Russia is
set to become the principal provider of energy to Western Europe, and Putin
is busy giving his corporate monoliths a friendlier face, hiring Gerhard
Schroder, Germany’s former chancellor, to chair Gazprom’s $5bn Baltic
Sea pipeline project, and trying (though failing) to recruit US politician
Donald Evans to Rosneft.

But Gazprom and Rosneft will both remain under state control, which raises
questions about how productive either is going to be, and how well run.

‘There is plenty of fat to be cut, especially at Gazprom,’ says Stephen
O’Sullivan, an analyst at Moscow-based United Financial Group. ‘But
painful cost- cutting and efficiencies aren’t greatest priorities when gas
prices are so high.’

Minority shareholders will also be powerless to prevent Putin using the
companies for political and diplomatic ends, as he appears to have done in
the recent Ukraine dispute.

Some, including Merrill Lynch, saw Russia’s dramatic decision to withdraw
the heavily subsidised gas supplies Ukraine has hitherto enjoyed as sound
commercial logic, and the inevitable consequence of Ukraine’s growing
political independence from Moscow.

But the episode has cast doubt on Russia’s reliability as an energy
supplier, not least because it led to temporary supply cuts to several
countries further west. Both the EU and America accused Russia of
heavy-handedness. In Britain, the incident will boost calls for nuclear
power and a lessening of our dependence on foreign imports.

Analysts agree that the Kremlin is determined to extract full political
capital from Russia’s emerging dominance in world energy markets. To
that end, it has used fair means and foul to bring more of the country’s
oil and gas assets under state control. It spent $7.5bn last year bringing
its shareholding in Gazprom up to 51 per cent – money that subsequently
helped the gas giant buy Sibneft from Roman Abramovich.

It barred foreign companies from owning energy assets deemed ‘strategic’.
Most controversially, it jailed oil oligarch Mikhail Khodorkovsky for fraud
and effectively renationalised Yukos, his highly profitable oil firm.

Yukos’s assets were confiscated and sold to Rosneft, tripling its asset
base in a stroke for the allegedly knock-down price of $9.5bn.

Putin’s tightening grip on the energy sector has commercial as well as
geopolitical implications. Private companies, which have driven exploration
and development in recent years, will now find it more difficult to win
licences and concessions; the Kremlin can be expected to award the most
lucrative work to Gazprom and Rosneft. And while that is no bad thing if
you are a minority investor in Gazprom and Rosneft, there are doubts that
either firm will exploit its favoured status as effectively as it could.

Neither, despite its size, is famed for its productivity or profit margins:
while Yukos and Sibneft used to enjoy 25 per cent annual growth in private
hands, government-owned Gazprom and Rosneft were stuck in single digits.

O’Sullivan believes their inefficiencies will be factored into their share
prices. But he adds that Rosneft might have more trouble finding takers for
its mooted plan to sell a further 25 per cent to a ‘strategic investor’: ‘I
don’t see the likes of Exxon or Shell taking part in a Rosneft auction. I
think the state having a dominant stake might put them off.’

Chris Weafer, an analyst at Alfa Bank, takes comfort from recent moves
on the Kremlin’s part to restructure the energy industry, introducing tax
breaks and involving Gazprom in liquefied natural gas, which can be
shipped for export.

But Weafer finishes with a word of caution for would-be Rosneft
shareholders: the company is still facing litigation from Yukos’s old
shareholders, who argue that the break-up of their company was illegal.

Should their claim succeed, it would have a devastating effect on the
company’s share price. ‘An [out-of-court] deal will have to be done
before Rosneft’s IPO,’ Weafer says. -30-
[return to index] [The Action Ukraine Report (AUR) Monitoring Service]
Power Corrupts and Absolute Power Corrupts Absolutely.

London, United Kingdom, Saturday, January 7 2006

Was Ronald Reagan right after all to have tried years ago to stop western
Europe tying itself to Russia’s gas pipelines? No, but the brief
interruption of Gazprom supplies to Ukraine and the knock-on effects on
other customers further west has sent a frisson of fear through Europeans
about Russia’s reliability as an energy supplier.

The incident has resurrected general energy security issues, and particular
concern about relying on a single state-controlled company for most of the
nearly half of the European Union’s gas imports that come from Russia and
one-quarter of its total gas consumption.

The main reason why the late US president’s opposition to Europeans becoming
such large customers for Siberian gas was misplaced is the mutual dependence
in the relationship. For one-fifth of Russia’s total export earnings come
from this piped gas that has no foreign outlet other than the EU.

Of course, if for some form of political blackmail Moscow chose to cut the
gas supply to Europe, it would suffer less than the EU; gas is harder to
store than foreign exchange. But in taking such a drastic step, Russia would
do far more damage to its own reputation as an energy supplier than the
Arabs did with their 1973 oil boycott. And what would be Moscow’s motive? In
contrast to Ukraine, EU states have long paid top price for Russian gas.

Nonetheless, it now makes even more sense for Brussels to pursue the EU
energy security review that Tony Blair set in motion during last autumn’s UK
presidency of the EU. The last such review was in 2000 when oil and gas
prices were far lower. Up to now the only real EU dimension to energy policy
concerned cross-border trade in gas and electricity. Improving competition
so that existing resources are put to best use is part of energy security.
But member states are very chary of granting Brussels a bigger role.

A couple of years ago they turned down a European Commission proposal that
they all hold a minimum level of emergency gas stocks. Such a scheme would
have been very reassuring over the past week and might be worth

One way to respond to a dominant seller such as Gazprom could be for EU
states to band together in a buyer’s cartel but that would flout EU
anti-trust rules. The proper, market-based way of limiting Gazprom’s market
dominance is for EU states to do more to multiply sources and types of fuel.

Can the EU help end the haphazard manner in which its member states arrive
at their energy mix and sources? Yes, but not in terms of EU directives
setting out that x per cent of EU gas should come from Russia and y per cent
from Algeria, or that w per cent of EU energy consumption should be gas and
z per cent nuclear. National governments do not even try to do that.

What the EU can usefully promote is the common interest in energy security
that its 25 member states share. The latter need to diversify gas import
pipelines and terminals, close the gaps between their power grids as well as
gas pipelines, and recognise the common interest can suffer as a result of
such national moves as mergers inside Germany that control distribution of
Russian gas, or the national decisions by Sweden, Belgium, Italy and Germany
to phase out nuclear power.

The way this week’s interruption of gas supplies to Ukraine cascaded on to
other countries is a reminder of energy interdependence and a lesson in the
need for more collective action. -30-
[return to index] [The Action Ukraine Report (AUR) Monitoring Service]

ANALYSIS: By Thomas Catan, Financial Times
London, United Kingdom, Sunday, January 8 2006

On a remote island off the eastern coast of Russia, encased in ice for
nearly half the year, the future of the world oil and gas industry is
beginning to take shape. And judging by the scale of the project that is
coming into being around the bleak shores of Sakhalin, that future will be
expensive, complex and, above all, big.

Off Sakhalin’s north coast, two of the largest concrete structures ever
built in Russia have been installed in the sea. As large as football fields
and as tall as 15-storey buildings, the offshore platform bases have been
towed in from 1,000 nautical miles away. Some 6,000 construction workers
labour in temperatures that can reach minus 40 degrees laying 800km
pipelines down the length of the island.

On the south side, Russia’s first liquefied natural gas plant is being built
in Aniva Bay. There the natural gas will be super-cooled into liquid form
and shipped to Japan, South Korea and the US – markets that have never
before had access to Russia’s massive gas reserves.

Europe came to realise just how dependent it had become on Russia for
energy after a new year spat between the Kremlin and Ukraine briefly
threatened its gas supply. Now Asia and the US are about to join the club.

After decades of false starts, the big push is under way to transform
Sakhalin into the world’s latest oil and gas province. A consortium led by
ExxonMobil started producing oil in October from its Sakhalin-1 project.
Sakhalin-2, led by Royal Dutch Shell, has also been pumping oil in the
summer months since 1999. But the second phase of Shell’s project, now
under construction, is of a wholly different scale. It is by far the largest
direct foreign investment in Russia and one of the largest integrated oil
and gas developments in the world.

“This is the biggest single project certainly that Shell has and, by most
measures, that anybody has,” says Chris Finlayson, Shell’s Russia country

The project is burning through $100 a second and occupying 60m person-
hours a year. When complete, it will deliver up to 150,000 barrels of oil a day
and 9.6m tonnes of LNG a year to Asia’s energy-hungry economies. Future
expansion could see a doubling of that capacity. But it is the scale of the
technical task that has led Shell managers to call it “the Mother of all

For Shell, the development is central to its plan to recover from a
difficult couple of years. The world’s third largest energy company by
market value has long lagged behind peers in the crucial business of finding
and exploiting new reserves of oil and gas. That turned into a crisis in
2004, when the company was forced to admit it had exaggerated the extent
of its “proved” reserves by around 40 per cent.

The admission triggered more than $150m in fines by financial regulators and
the departure from the company of Sir Philip Watts, chief executive. The
company has always argued that the reserves are still there – that it merely
overstated how close they were to being brought to market. Big projects such
as Sakhalin are therefore crucial if Shell is to develop more of the
resources it has in the ground.

However, Sakhalin-2 has been anything but easy, testing Shell’s management
abilities to the limit. The project, of which Shell owns 55 per cent, has at
times appeared to be slipping out of its control. (The other shareholders in
Sakhalin Energy, the company that operates the project, are Mitsui & Co and
Mitsubishi Corporation of Japan.)

When Shell first approved the development, the budget through 2014 was
$10bn. Last July, the group admitted the cost had ballooned to $20bn.
Although the industry as a whole is suffering from cost inflation, the scale
of the increase suggested that Shell had greatly underestimated the
difficulties of carrying out the project in such a tough environment.

The admission hurt Shell’s hard-won reputation for being able to manage
large and complex projects and stalled the turnaround plan of Jeroen van
der Veer, who took over from Sir Philip. It also complicated Shell’s
relationship with the government in Russia – a country it believes is key
to rebuilding its energy reserves.

“I fully realise it has an impact on our reputation – certainly for this
project – and then of course I’m concerned it will carry over to other
things that we do,” Mr Van der Veer said in an interview last year. Shell’s
chief executive believes the company’s future lies in multibillion-dollar
projects such as Sakhalin-2 – what he terms “elephant projects”. At the
moment, Shell has three elephant projects under way. In a decade’s time, Mr
Van der Veer wants Shell to have 10 such projects on the go concurrently.

For the moment, he has had to occupy himself with limiting the fall-out from
the rising cost of Sakhalin-2. The Shell-led consortium is in talks with the
Russian government over the revised budget but those are not proving easy.
The higher price tag will delay the day when Moscow will start to see
revenues from the project.

Russia will still get an estimated $50bn from the project over its lifetime
but that has not stopped the government from piling on the pressure. On a
recent state visit to the Netherlands, Vladimir Putin, Russia’s president,
personally made his displeasure about the cost overrun known to the Shell

The events may have hurt Shell’s ambitions in Russia. Since the announcement
of the jump in costs, Gazprom, Russia’s state-controlled gas monopoly, has
denied Shell a stake in its giant Shtokman gas field in the Barents Sea,
north of Europe. Russian officials have hinted that Shell’s problems at
Sakhalin were partly to blame.

To make matters worse, Gazprom was due to take a 25 per cent stake in
Sakhalin-2 under an asset swap with Shell, announced only a fortnight before
the size of the cost overrun became apparent. Gazprom is now driving a much
harder bargain.

Although Shell has suffered uniquely during the difficult gestation of the
project, it is not alone. With the easy pickings gone, the industry as a
whole is having to look farther afield to develop oil and gas. Many of the
new opportunities will lie in environments every bit as difficult as

“One of the challenges is, ‘Where are you going to drill now?'” says Frank
Harris, LNG analyst at Wood Mackenzie, the consultancy. There is further
scope for exploration around the Barents Sea, he adds. But extracting it
will be far from easy. Statoil, Norway’s state oil company, has already run
into problems at its ambitious Snohvit LNG development, which is running
around a year late and 50 per cent over budget.

Shell can sympathise. “It was a lot easier when you could just get oil out
of your backyard in Texas,” says John Burn, the construction manager for
Sakhalin Energy’s northerly oil processing facility. “Now you have to come
out to places like Sakhalin.”

The list of obstacles faced by Shell and its partners is daunting. Sakhalin’s
arctic climate and remote location make it an inhospitable place to live,
let alone build such an ambitious project. Winter temperatures average minus
24 degrees Celsius (minus 11 Fahrenheit) and the island is located in the
middle of a typhoon area.

The platforms have had to be specially designed to withstand the massive ice
floes that can crumple into their sides at speeds of more than 2 metres a
second, as well as earthquakes that frequently shake the island. Ten years
ago, a quake measuring 7.5 on the Richter scale killed 2,000 people in the
town of Neftegorsk.

It is not the only danger. Sakhalin was long fought over by Russia and Japan
and is littered with unexploded ordnance. Shell has already cleared around
900 rusting bombs from construction areas.

Sakhalin’s pristine environment has meanwhile made Shell the target of
campaigners around the world. An endangered population of only 100 western
gray whales feed on Sakhalin’s north-eastern shore during the summer months.
The Shell development threatens their existence, environmental groups

To allay concerns, Shell re-routed the undersea pipeline from one of its
platforms to avoid the feeding ground, at a cost of more than $300m. Shell
also devised a way to install the offshore platforms more silently to avoid
scaring off the whales during the feeding season, again at greater cost.

Environmental groups also fear that the construction of the twin pipelines,
which cross 1,000 rivers and streams, will interfere with salmon spawning
and harm the island’s fishing industry. “Salmon can’t spawn in a dirty
river,” says Dmitry Lisitsyn, chairman of Sakhalin Environment Watch,
showing pictures of mud-caked river banks where the pipeline has been built.
“We have found many, many violations [of company procedures].”

David Greer, project manager for Sakhalin-2, says that some of the scenes
captured by Mr Lisitsyn are “regrettable but very much in the minority”. He
says that procedures have since been tightened up.

The company is drilling under rivers that are held to be particularly
sensitive and has sought to allay fears about its impact on the island’s
fishing industry. After some inhabitants objected that a new jetty would
block the progress of salmon along Aniva Bay, the company installed three
tunnels at a cost of $2m. Subsequent monitoring has found that the salmon
merely swim around the jetty.

“From an environmental point of view, it’s useless,” concedes Harald
Hansen, the site’s environmental engineer. But he says that if such measures
increase the confidence of the local population, they will have been
worthwhile. So far, the fish appear to have been unaffected by the
construction work – 2005 was a bumper year for salmon there.

A bigger concern is that the company does not have a plan for what to do in
the event of an oil spill under ice. It says it is working hard to come up
with one.

As if all of this was not difficult enough, foreign companies must contend
with the difficulties of doing business in a country that retains much of
its Soviet-era bureaucracy. The company has 45 people dedicated to securing
permits and paperwork from up to 15 government entities. Many more people
are involved in the process at any one time. “We’ve got permits coming out
our ears,” says Mr Greer. “There is a huge machine that you have to work

Shell makes clear it is not complaining, however. Given the dearth of
opportunities for oil companies, the group knows it must make a success
of projects such as Sakhalin if it is to turn itself around.

“This is what the big oil companies have to get right, because these are the
opportunities of the future,” says Ian Craig, Sakhalin Energy’s chief
executive. “That’s the competitive niche that the Shells, the Exxons and BPs
have to work at. A lot of the key opportunities going forward are going to
be in these sorts of environments.”
No one doubts the size of the prize at Sakhalin. An estimated 45bn
recoverable barrels of oil-equivalent lie beneath its shores – the same
quantity as in the British, Norwegian and Dutch sectors of the North Sea

Located off the eastern coast of Russia, Sakhalin sits in the middle of the
world’s fastest-growing energy consumers: China, Japan and South Korea on
one side, the US on the other. The reserves and their proximity to big
markets combine to make Sakhalin one of the most strategically important oil
provinces to have been developed in recent years.

Until recently, however, Sakhalin had attracted relatively little attention
from Moscow, one of the reasons it has developed along a different track to
the rest of the Russian oil industry.

Perhaps that is not surprising. Sakhalin was only recently linked to Moscow
by a direct flight – before that, the island was easier to reach by boat
from Japan.

Rosneft, Russia’s state oil company, has for years produced a modest amount
of oil onshore from Sakhalin – old derricks still dot the frozen landscape.
But the island’s huge offshore reserves were too expensive and technically
challenging to develop without foreign companies. An agreement in 1994 by
the government of Boris Yeltsin, then president, heralded the start of tens
of billions of dollars of investment into the island.

Shell is one of a number of foreign energy companies in Sakhalin. An
ExxonMobil-led consortium is producing oil and BP, too, has a presence,
though at this stage it is only exploring and has no agreement to develop
any fields.

The oil industry is transforming Sakhalin, a sparsely populated island
nearly 1,000km long and covering an area roughly the size of Scotland.
After the fall of the Soviet Union, the population began to fall rapidly as
Russians were able to move about more freely within the country and
beyond. Since 2002, however, the island’s population has stabilised at
around 550,000 and unemployment has fallen to 1 per cent.

Many tens of thousands of temporary workers have come from the Russian
mainland. Hotels are springing up all over Yuzhno-Sakhalinsk, the capital,
along with bars and clubs filled with expatriates. Inevitably, local
inhabitants complain that prostitution has become rife throughout the

Until recently, fishing was Sakhalin’s biggest industry and many fear that
it could be hurt by the construction work. But in spite of some claims for
compensation by fishing companies, overall stocks have not yet been
affected, says Viktor Fokanov, secretary of Sakhalin’s Fishermen Club.
Local environmentalists agree but are concerned that the impact on salmon
spawning may be felt in years to come.

Mr Fokanov also complains that the best fishermen have left to work on the
project, depriving the industry of vital skills.

Long a forbidding and highly isolated place, Sakhalin was once a Tsarist
penal colony. Anton Chekhov, the Russian writer, travelled the 5,000 miles
from Moscow to investigate conditions in Sakhalin during that period and
declared the place “hell”.

In 1905, Japan occupied the lower half of the island. The Japanese remained
there for four decades, until they were expelled by Russia at the end of the
second world war.

Ironically, Japan will become one of the first, and most important, buyers
of LNG from Sakhalin when deliveries start in less than three years’ time.
. 1975 – The Soviet Union and Japan sign an offshore exploration agreement
. 1994 – A foreign consortium signs Russia’s first production-sharing
. 1999 – First offshore oil is shipped from Sakhalin
. 2003 – Sakhalin Energy approves a huge phase-two project
. 2005 – Royal Dutch Shell announces that the cost of the project has
doubled to $20bn
. 2008 – First shipment of Russian liquefied natural gas is expected
FOOTNOTE: I made an economic development trip to Sakhalin
a few years ago. Great potential there for high-quality fish products
especially if the market in Japan would really be open. Considerable
interest in their wood products also. The Soviets exploited the island
and its resources sucking much more wealth out than was put in for
building needed infrastructure and business investment. EDITOR
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FT COLUMNIST: By Wolfgang Munchau
Financial Times, London, UK, Sunday, January 8 2006

The two overriding objectives of the European Union’s future energy policy
should be to secure supplies and ensure environmental sustainability. It is
currently in danger of failing in both. The Russian-Ukrainian gas dispute
has reminded us of our dependence on Russian gas. The EU is also missing
its Kyoto targets to reduce greenhouse gas emissions by a wide margin.

If Europe is serious about meeting both goals, it will need a new energy
mix – one that would include both nuclear and alternative energy sources,
combined with policies to encourage energy efficiency. While nuclear energy
is not the answer to all our energy problems, it has to be part of any
answer. The scientific and strategic case for a return to nuclear energy in
the EU is overwhelming.

The issue is very much back on the agenda. Tony Blair, the British prime
minister, has ordered a domestic energy review to look at the future of
nuclear power. Michael Glos, the German economics minister, suggested that
Germany should rethink its decision to bail out of nuclear power by 2020. In
Brussels, Andris Piebalgs, the European energy commissioner, promised a
review this year to “look at our general energy mix”. This is almost certain
to include a discussion on nuclear energy.

Nuclear energy is not risk-free. In the 1970s and 1980s, the debate was
about whether we would be prepared to accept this new technology at the
expense of what we were told would be a small accident risk. Today’s debate
is different. For one, the accident risk is considerably smaller. But there
are also equally grave risks attached to going non-nuclear, the biggest of
which is an increase in greenhouse gas emissions.

Scientists have been warning about the effects of phasing out nuclear energy
on future greenhouse emissions. In the UK, nuclear energy’s part in total
energy production would fall from 24 per cent today to about 4 per cent by
2020. Sir David King, chief scientific adviser to Mr Blair, said that if
this gap were filled by traditional power stations, the UK would almost
certainly miss its greenhouse gas targets.

Last November, the German Physical Society* published an alarming report
about the consequences of phasing out nuclear energy in Germany. If nuclear
capacity was replaced by modern conventional power sources, this would lead
to an annual increase in CO2 emissions of between 100m and 120m tonnes.
This dwarfs the greenhouse savings promised by alternative energy sources.

But it is far from clear whether the EU’s political classes are ready for a
change in nuclear policy. Germany, which accounts for roughly one-quarter
of EU greenhouse gas emissions, is going to be pivotal. Angela Merkel, the
German chancellor, is personally in favour of nuclear energy but has said
she will not question the coalition agreement, which commits the present
government to the existing phase-out timetable. Both the Social Democrats
and the Greens vigorously oppose nuclear power.

For the present political generation, the anti-nuclear movement was one of
the defining moments in their early political careers. It not only gave rise
to green parties all over Europe but heavily influenced the political left –
though, interestingly, this was never true of France where nuclear energy
has enjoyed broad political support. Elsewhere in continental Europe,
opposition to nuclear energy is so deep-rooted that even a dangerous rise
in greenhouse gas emissions cannot change the views of a seasoned anti-
nuclear campaigner. Whenever you raise the issue of nuclear energy, you
can be guaranteed that the debate gets irrational and emotional.

There are big differences among EU countries. Finland, for example, has
been alone in commissioning a new power station at a time when others are
decommissioning. The UK is in the process of reconsidering its position.
In France, nuclear energy is very strong and likely to remain so.

Yet energy policy is one of those classic areas where the logic of
collective action at EU level is overwhelming. We all face the same
problems, both in terms of emissions and in terms of security of supplies.
Our economies are all highly sensitive to movements in energy prices. In
fact, it is not easy to make a convincing intellectual case for national
energy policies in a single European market.

At an EU summit in October last year, Mr Blair surprised everybody when
he called for an enhanced European energy policy that included four pillars:
better interconnection between national power grids, EU-wide co-operation
on gas storage, better exchange of information on security issues and a
commitment to reduce greenhouse gas emission.

Mr Blair is right. Europe needs a common energy policy and it also needs
a rethink on nuclear power. I am not holding my breath: there is too much
political resistance. But let the debate commence.
(* (
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