AUR#919 Dec 8 Ukraine Macroeconomic Situation; IMF; Inflation; Currency Falls; Mars, EPAM, European Gas & Ukrainian Reality

 
ACTION UKRAINE REPORT – AUR       
An International Newsletter, The Latest, Up-To-Date
In-Depth Ukrainian News, Analysis and Commentary

Ukrainian History, Culture, Arts, Business, Religion, Economics,
Sports, Government, and Politics, in Ukraine and Around the World       
 
ACTION UKRAINE REPORT – AUR – Number 919
Mr. Morgan Williams, Publisher and Editor, SigmaBleyzer
WASHINGTON, D.C., MONDAY, DECEMBER 8, 2008
 
INDEX OF ARTICLES  ——
Clicking on the title of any article takes you directly to the article.               
Return to Index by clicking on Return to Index at the end of each article
Monthly Analytical Report: By Olga Pogarska, Edilberto L. Segura
SigmaBleyzer Emerging Markets Private Equity Investment Group,
The Bleyzer Foundation, Kyiv, Ukraine, Monday, December 8, 2008
 
2 DEFAULTING COUNTRIES REACH OUT TO IMF AND FINANCIAL FIXERS
In the hangover of the credit crisis where neither Baugar nor Budapest are safe – the rescue business is seeing a comeback.
By Helia Ebrahimi, Telegraph, London, UK, Monday, 08 Dec 2008
 
3.  UKRAINE SEEKS ADVISER IN CASE OF EARLY DEBT PAYMENT
Reuters, Kiev, Ukraine, Wednesday, December 3 2008
 
By Kateryna Choursina, Bloomberg, New York, NY, Monday, December 8, 2008
 
By Daryna Krasnolutska, Bloomberg, New York, NY, Sunday, December 7, 2008
 
6UKRAINE GOVERNMENT WORSENS ECONOMIC PREDICTIONS
Deutsche Presse-Agentur, Kiev, Ukraine, Wednesday, Dec 3, 2008
Ukraine’s hryvnia has lost more than 60% from a peak of 4.50 to the U.S. dollar in the spring.
By Geoffrey Smith, The Wall Street Journal, New York, NY, Wed, Dec 3, 2008
 
By Serhij Lyamets, The Ekonomichna Pravda, in Ukrainian, Kyiv, Ukraine, Monday, Dec. 1, 2008
 
9UKRAINE’S CENTRAL BANK HELPS MAKE $23-BILLION DENT IN POCKETS OF UKRAINIANS
Commentary & Analysis: By Volodymyr Hrytsutenko
Professor of Current Ukrainian History, Lviv Franko University, Lviv, Ukraine
Action Ukraine Report (AUR), Kyiv, Ukraine, Monday, December 8, 2008
 
Commentary & Analysis, By Volodymyr Lanovy
Radio Free Europe/Radio Liberty (RFE/RL), Prague, Czech Republic, Wed, Dec 03, 2008
 
Confectionery, food, beverage, health & nutrition, pet care products company. USUBC member 98.
U.S.-Ukraine Business Council (USUBC), Washington, D.C., Tue, Dec 2, 2008
IMB Group, Kyiv, Ukraine, Wednesday, November 12, 2008
 
Southern Research Institute, Birmingham, AL, Monday, December 1, 2008
By Edward Chow and Jonathan Elkind, The Washington Quarterly, pp. 77 – 93
Journal of the Center for Strategic and International Studies (CSIS), Washington, D.C., January, 2009
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1
 UKRAINE MACROECONOMIC SITUATION REPORT, NOVEMBER 2008

Monthly Analytical Report: By Olga Pogarska, Edilberto L. Segura
SigmaBleyzer Emerging Markets Private Equity Investment Group,
The Bleyzer Foundation, Kyiv, Ukraine, Monday, December 8, 2008

SUMMARY:

• Ukraine’s real economy has continued to perform well with a real rate of GDP growth of 6.9% yoy in January-September 2008. However, Ukraine’s
near term outlook has worsened substantially, although medium-term prospects remain good.

• Over the first nine months of 2008, the consolidated budget was in surplus of UAH 11.8 billion ($2.3 billion) or 1.6% of period GDP, backed by
above-target revenues and tight control over expenditures. With weak prospects of fully covering the planned financing gap and the likely shortfall in revenues through the rest of the year, the government started to revise their expenditure plans. As a result, the fiscal deficit is likely to be significantly below target.

• Following two months of inflation relief, consumer prices returned to growth, advancing by 1.1% month-over-month in September. Though inflation continued to decelerate in annual terms, government plans to adjust a number of service tariffs will notably hinder this process in the coming months.

• With rapidly widening trade and current account deficits, large external debt financing needs and high banking system exposure to credit and foreign
currency risks, Ukraine was and remains extremely vulnerable to adverse external shocks. On the back of heightened global financial instability since September, falling world steel prices and a weakening global economy, these risks started to materialize during September-October.

• Reflecting growing stress to the Ukrainian economy, major international rating agencies downgraded Ukraine’s sovereign rating.

• Despite the recent turbulences, the prompt government and monetary authorities’ response as well as gained support from international financial
institutions increases the chances that Ukraine may be able to weather the storm with relatively moderate pain.

ECONOMIC GROWTH 

Buoyed by outstanding performance in agriculture, real GDP growth picked up to an impressive 10.4% yoy in August, bringing cumulative growth to 7.1% yoy. At the same time, the Ukrainian economy is likely to lose steam through the rest of this year and also 2009, courtesy of both external and domestic factors.

Resilient so far, Ukraine’s heavily export-oriented and external-financing-dependent economy looks increasingly vulnerable to the recent financial crisis. Weakening external demand has already manifested through plunging world commodity prices, while foreign investors’ flight-to-quality and risk aversion may dry up foreign capital inflows to emerging markets.

On the domestic front, lingering inflationary pressures and political instability, weaknesses in the domestic banking system, a rapidly widening trade deficit
and large private sector indebtedness subdue Ukraine’s economic outlook in the near future.

Already in September, real GDP growth slowed to 5.5% yoy on the back of weaker industry, domestic trade and construction. Cumulatively, however,
economic growth decelerated only marginally to 6.9% yoy, supported by strong value added growth in agricultural and the transportation and communication sectors.

Thanks to a 15-year record grain harvest, agriculture expanded by 15.7% yoy over the first nine months of the year. At the same time, due to unfavorable weather conditions in September, the harvest of corn, sugar beets and some other crops and vegetables turned out to be less successful than previously expected. This explains value added growth deceleration in January-September compared to an explosive 24.4% yoy increase in January-August.

Transportation and communication kept expanding at a robust 10.4% yoy over January-September, virtually the same rate as in 1H 2008, according to the revised State Statistics Committee data.

On the other hand, construction plunged by 10.3% yoy over the first nine months of the year, affected by tight access to credit. The industrial sector also
continued to decelerate and grew by only 5% yoy due to weaknesses in the global demand for iron, steel and chemical products. In particular, following
several months of deceleration, metallurgical production has been contracting in annual terms since August, in line with the sharp decline in world steel prices.

In September, output in industry fell by 17% yoy, driving cumulative growth below zero. October is likely to see another major decline in industry as a number of metallurgical producers announced production and employment cuts.

The depression in the metallurgical sector will exact a significant toll on the whole Ukrainian economy as the sector accounts for more than 45% of total
export revenues and about 25% of total industrial production. In addition, poor metallurgical performance will also affect a number of other industries
and sectors, including the extractive industry, machine-building, construction, and transportation.

Expectations that the new harvest will improve food processing performance did not materialize. Industrial production grew by a modest 2.2% yoy over the first nine months of the year, decelerating from about 10% yoy at the beginning of the year. Weak external demand was among the main reasons of worsening chemical industry performance.

Over the nine months, output growth in export-oriented chemical production slimmed down to 2.9% yoy compared to 9% yoy growth at the
beginning of the year.

After all, warning signs of economic weakness were already evident in the second quarter of 2008. In particular, investments advanced by only 6.3% yoy as tighter monetary policy limited access to banks’ credit. Private consumption growth decelerated to 13.3% yoy, down from almost 18% yoy in the previous quarter. A domestic trade slowdown to 9.4% yoy in January-September from 13% yoy in 1H 2008 foretells further weakening of domestic
consumption in 3Q 2008.

Moreover, while exports rebounded at a strong 9% yoy (up from less than 1% yoy in 1Q 2008), imports continued to outpace exports, expanding by a record high 25.6% yoy in 2Q 2008. Ukraine’s deteriorating current account balance puts pressure on economic growth and increases the country’s dependence on external capital flows.

On the back of easing steel prices, tight external and domestic credit markets amid large external financing needs, a cooling world economy and recent
turbulence on the domestic financial market (which is likely to cause a further credit squeeze and aggravate domestic banking sector weaknesses),
Ukraine’s near-term outlook has worsened substantially. Economic growth is forecasted to decelerate to 6.3% yoy in 2008 and enter a downturn in 2009.

At the same time, the country maintains a good medium-term outlook, supported by a large domestic market, great agricultural potential, a cheap and skilled labor force, good prospects for signing a free trade agreement with the EU and greater chances of reform acceleration (in part thanks to recently applying to the IMF financing).

FISCAL POLICY 

Ukraine’s public finances remained in a good shape as the country ran a consolidated budget surplus of UAH 11.8 billion ($2.3 billion) though the end of
September, which is equivalent to 1.6% of period GDP. Public spending rose by a nominal 41% yoy over the first nine months of the year, underpinned
by higher spending on public wages and social transfers.

In particular, remuneration to public sector employees grew by a nominal 38.1% yoy, while current transfers to the population advanced by 48% yoy. Despite strong growth, fiscal expenditures were still below target mainly due to under-execution of capital spending. The government refrained from tightening social expenditures in view of the turbulent political environment and looming presidential elections (scheduled for early 2010).

At the same time, though expenditures notably increased, they were still below the targeted amount. According to the State Treasury, expenditures from the general fund of the state budget were under-executed by about 3%. Together with above-planned revenues, this secured a budget surplus for the period.

During January-September, consolidated budget revenues grew by 43.7% yoy in nominal terms over the first nine months of the year backed by a 53% yoy increase in tax receipts. As in the previous periods, value added tax proceeds, advancing by almost 70% yoy in nominal terms, were the main contributor to tax revenue growth over the period.  Defined usually as the tax on consumption, impressive growth in VAT receipts this year is explained by high inflation,  robust imports, and improved tax administration.

In parallel, however, the authorities started to accumulate VAT refund arrears, as it became clear in the middle of the year that the targeted amount for

VAT refunds, envisaged in the 2008 budget law, was significantly underestimated. In January-September, VAT reimbursement was 43% above the planned amount. According to expert estimates, VAT refund arrears amounted to UAH 11 billion (about $2 billion) at the end of September, up from about UAH 8 billion in the middle of the year.

However, the situation is unlikely to improve until the end of the year, as a reduction in arrears will require a budget revision, the likelihood of which looks quite low. At the same time, the accumulation of further arrears may lose speed substantially through the rest of the year given notable export weakening.

Execution of other taxes, particularly corporate and personal income taxes, has been good in January-September, as proceeds from these taxes picked up by a nominal 57% yoy and 38% yoy respectively. Despite current favorable budget performance, successful budget exercise through the rest of the year looks quite worrisome.

First, due to further projected worsening of economic performance through the rest of the year and government initiatives to introduce tax benefits for a number of industries affected by a sharp deterioration in the external environment, budget revenues risk being substantially under-executed.

However, above-target revenues and strict control over expenditures allowed the government to accumulate significant cash balances on its Treasury account (about UAH 16 billion at the end of September).

Second, the financing gap, targeted at about UAH 19 billion, or 1.8% of expected 2008 GDP, looks insurmountable. The budget deficit was planned to be financed by new government borrowings (both external and internal) and privatization proceeds.

Despite the greater reliance on domestic debt financing this year, Ukraine’s fiscal authorities still planned to raise UAH 8.1 billion ($1.6 billion) in foreign borrowing, including about $1 billion by placing Eurobonds, for which a road-show was conducted in June.

However, on the back of tight external credit markets and investors’ flight to safety, the government decided to shelve the bond issuance. At the same time, reliance on domestic debt issuance also was not very successful. Given frankly unattractive yields amid high domestic inflation, the authorities raised only UAH 1.4 billion into state coffers in January-September, or less than 20% of the targeted amount for this year.

And finally, government plans to receive UAH 8.8 billion ($1.5 billion) in the form of privatization receipts this year will not materialize. At the end of September, the accumulated privatization proceeds amounted to less than 4.5% of the annual target.

With the deteriorating prospects for an already slowing economy and the lack of targeted fiscal deficit financing, the government started to revise their expenditure plans. In particular, the President and the Cabinet of Ministers issued a number of Decrees, envisaging expenditure cuts on public administration.

Moreover, the government is likely to continue to tightly control expenditures through the rest of the year. This would mean moderate expenditure
loosening in the last couple of months. However, the year-end fiscal deficit may turn out to be significantly lower than previously expected.

Presented in September, the draft Budget Law for 2009 is likely to be recalled or significantly amended, as it was developed prior to financial stresses on both the external and domestic markets and deteriorated prospects for the next year. Moreover, the targeted deficit of UAH 17.4 billion ($3 billion), or 1.4% of GDP, is not in accordance with the government’s commitment to the IMF to maintain a balanced budget in 2009.

A prudent fiscal stance is considered the most effective measure to cool aggregate demand, tackle inflation and narrow the foreign trade deficit. Given the turbulent political environment, it looks like the 2009 budget law will be approved next year.

MONETARY POLICY 

Monetary policy tightening, appreciation of the national currency in May, and a record harvest caused prices to fall during July-August. As a result, annual inflation continued to decelerate, reaching 26% yoy in August, down from its peak of 31.1% yoy in May. However, two-month deflation was a temporary relief as in September, monthly inflation advanced by 1.1%.

However, inflation kept slowing in annual terms to 24.6% due to a high statistical base. A rise in monthly inflation reflects a 3.8% mom increase in utility tariffs (starting September, natural gas prices for the population were increased by 13–14%), 21.2% mom growth in the cost of education services and 1.2% mom more expensive services in restaurants and hotels and higher excises on tobacco.

Some relief was brought by declining gasoline prices (down by 6% mom in September) consistent with falling world crude oil prices.While inflation is expected to decelerate further through the end of the year, its pace will be much slower.

First, easing inflation provided the government authorities with some room to adjust a number of regulated prices and tariffs. A 20% rise in communication tariffs since the beginning of October, another 35% increase in natural gas tariffs for households since the beginning of December, and multi-fold increases
in utility tariffs for legal entities and transportation tariffs in Kyiv, the capital and the largest city of Ukraine, were already announced.

Second, the recent sharp depreciation of the national currency may spill-over into domestic inflation as it will make imported goods more expensive. Although the substitution effect will be present, it may be quite limited for a number of inelastic goods such as medicines, energy, etc. Annual inflation
is expected to slow moderately to about 22% yoy in 2008.

Unfavorable sentiments formed amid recent intensification of global financial turmoil and Ukraine’s deteriorating fundamentals prompted foreign investors
to more actively withdraw capital from the country. A combination of falling world steel prices and weakening external demand, a large current account deficit and sizable payments due on private sector external liabilities, weaknesses in the banking system (high exposure to credit and foreign exchange risks) as well a new wave of political instability since September tilted the balance towards sharp Hryvnia depreciation.

The NBU refrained from active support of the exchange rate, allowing it to depreciate, which was consistent with May’s decision to switch towards a managed float regime. The NBU, however, wanted a smooth exchange rate adjustment to its market clearing level by selling limited amounts of foreign currency on the interbank foreign exchange market.

This strategy resulted in a loss of $4.5 billion in the NBU’s foreign exchange reserve during September-October and in a depreciation of the Hryvnia by about 27% of its value against the US dollar over the period (to UAH/USD 5.95 on average on the interbank market at the end of October).

Devaluation may also intensify stress on the banking sector due to existing currency mismatches of banks’ assets and liabilities. Although the level of
indebtedness of the Ukrainian private sector is far below that of developed countries, more than half of all loans issued by commercial banks are denominated in foreign currencies.

This means that local borrowers are particularly exposed to currency risks. On top of that, the sixth largest Ukrainian bank suffered a bank-run by depositors in September. Although the National Bank of Ukraine responded quickly by providing UAH 5 billion (about $1 billion) of emergency refinancing and later took control of this bank, this occurrence undermined confidence in the banking system.

To minimize counterparty risks in the banking sector, commercial banks cut or closed their bilateral credit limits, restraining commercial bank access to
domestic finances. In addition, the population rushed to withdraw funds from their deposit accounts. The NBU’s active support of a number of
commercial banks with liquidity through its refinancing operations calmed these fears. In October, it provided UAH 29.3 billion (about $5 billion).

To avoid bank-runs, the NBU has imposed a six-month freeze on the early withdrawal of savings deposits from commercial banks. Simultaneously,
an increase in the deposit guarantee was suggested to UAH 150,000 (about $25,800), tripling from the previous level. The NBU has also imposed tight limitations on the capacity of the commercial banks to expand their credit portfolio.

Although the NBU softened this restriction a few days later, trying to avert a local credit crunch, the ban on foreign currency loans to borrowers without
foreign currency income was left intact. The NBU strengthened its monitoring capacity of external private sector debt. In particular, it required commercial
banks to report data on their and their clients’ external liabilities maturing each quarter over the next 12 months.

Government officials have also considered the establishment of a stabilization fund, which would work with a government-owned Asset Recovery Company to buy and resolve some of the distressed assets of the banks.

Ukrainian authorities applied for IMF financing support and on October 26th, an agreement was reached on a two-year $16.5 billion stand-by IMF loan. Given the above measures and support from the international financial institutions, Ukraine may still weather the storm with relatively moderate pain.

INTERNATIONAL TRADE AND CAPITAL 

Ukraine’s foreign trade data, released by the State Statistics Committee for January-August, still demonstrate a rather favorable picture. Exports kept increasing fast, advancing by an impressive 48.5% yoy over the first eight months of the year. An outstanding harvest triggered a surge in grain exports,
which expanded by 120% yoy over the period.

High world iron ore, coal and energy prices over the period underpinned an almost 70% yoy increase in mineral products exports, whose share grew to 10.4% of total merchandise exports, up from 9% in the respective period last year.

Weakening of world steel prices, which was observed since July, had a minor impact on Ukraine’s exports of metallurgical products in August. Export of the weightiest group of commodities surged by 60.6% yoy, bringing cumulative growth to 54.5% yoy.

Robust economic growth in Ukraine’s main trading partner countries supported a 40.5% yoy increase in exports of machinery and transport equipment. At the same time, export growth started to decelerate in August as exports in value terms were by about $1 billion lower compared to the previous month.

Although a decline in world iron ore, steel and energy prices, tighter domestic credit conditions and slower growth in real households’ income contributed
to a deceleration in imports in August, rates of growth remained at an impressive 63% yoy that month (down from almost 70% yoy in July) and 58.3% yoy to date.

As imports continued to notably outpace exports, the FOB/CIF merchandise trade deficit widened to $12.5 billion over the first nine months of this year. A deteriorating foreign trade balance is the main cause of the widening current account gap. According to preliminary estimates of the NBU, the CA gap widened to $7.5 billion in January-August, representing 6% of period GDP.

Over the period under review, this amount was fully covered by foreign direct investments, estimated at $8.1 billion over the period. However, the
current account gap is expected to reach $12–13 billion, or about 7% of GDP, in 2008.

In addition to this, Ukraine will need to serve significant foreign short term debt. As of June 2008, out of total external debt outstanding of $100 billion,
about $28.2 billion was due up to one year. At the same time, the NBU registers external debt by original maturity.

This means that if the short-term portion of the long term debt is included, the total amount of external debt refinancing may be as high as $40–45 billion. Although a portion of this sum is either due by subsidiaries to parent companies or represents more stable trade credits, the net external financing requirements still remain at a substantial $25–30 billion.

While this amount looks manageable, amid a turbulent global environment marked by risk aversion and worsening macroeconomic fundamentals, raising it may be very difficult, which points to rising stress on Ukraine’s balance of payments.

Although official data is not available yet, very high risk premiums on Ukraine’s securities, a decline in portfolio investments, partly as a result of which the country’s stock exchange (PFTS) index has declined by more than 80% year-to-date, and finally sharp currency depreciation during September-October show that the above risks have started to materialize.

On a positive note, declining world crude oil prices increase chances that the natural gas price increase on imported gas in 2009 may be significantly lower than in was previously anticipated. Coupled with the implementation of a government program developed in close cooperation with the IMF to restore financial and macroeconomic stability, current account pressures will ease substantially. The current account gap is now forecasted to decline to
about 3% of GDP in 2009.

OTHER DEVELOPMENTS AFFECTING INVESTMENT CLIMATE 

Following rapid deterioration of macroeconomic fundamentals, currency pressures and increased worries over banking sector health, international
rating agencies downgraded Ukraine’s sovereign ratings as well as individual ratings of a number of private companies and commercial banks.

For the same reasons, the Ukrainian authorities applied for IMF financial support at the beginning of October. On October 26th, a tentative agreement
was reached on a two-year $16.5 billion stand-by agreement. The final decision was conditioned on the parliament’s approval of a number of legislative
initiatives, including approval of a bank recapitalization program and a firm commitment to prudent fiscal policy coupled with tighter monetary policy.

Despite a turbulent political environment, the government authorities promptly developed the “stabilization” package, which was approved by the parliament at the end of October. For the Parliament vote to be legitimate, the President has suspended the dissolution order of the Rada. Moreover, early
parliamentary elections called by the President at the end of September are likely to be delayed until spring of next year.

Although the approval of the IMF financial support package is not a panacea, it sends positive signals about the possibility that Ukraine may weather the storm with relatively moderate pain.

The IMF support also opens other alternative external sources of financial assistance to Ukraine. In particular, the World Bank has already announced it is
revising its program of cooperation with Ukraine to provide rapid assistance in hot areas, such as restructuring and recapitalization of the banking sector, improving support to the poor, deepening of structural reforms to restore Ukraine rapidly to sustainable economic growth, etc.

UKRAINE, BULGARIA, ROMANIA, & KAZAKHSTAN MACROECONOMIC REPORTS —–

NOTE: To read the entire SigmaBleyzer/The Bleyzer Foundation Ukraine Macroeconomic Situation update report for November 2008 in a PDF format, including color charts and graphics click on the attachment to this e-mail or go to the following link, and click on Ukraine November 2008,
http://www.sigmableyzer.com/publications/monthly_reports. SigmaBleyzer/The Bleyzer Foundation also publishes monthly Macroeconomic Situation reports for Bulgaria, Romania and Kazakhstan. The present and past reports, including those for Ukraine can be found at http://www.sigmableyzer.com/en/page/532.

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

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2.  DEFAULTING COUNTRIES REACH OUT TO IMF AND FINANCIAL FIXERS
In the hangover of the credit crisis where neither Baugar nor Budapest are safe – the rescue business is seeing a comeback.

By Helia Ebrahimi, Telegraph, London, UK, Monday, 08 Dec 2008

LONDON – Exactly one year on from having its resources slashed and it relevance questioned, the International Monetary Fund has put record amounts of
emergency loans to work.

A staggering $41.8bn (pounds28.6bn) of cash was carved up in November alone between Iceland, Hungary, Serbia, Ukraine and Pakistan, with a further $10bn bail-out being finessed this weekend to pull Turkey back from possible default.

But the IMF is not the only one saving sovereign states.

The buccaneers of restructuring, already busy breathing oxygen into the lungs of debt-choked companies, like retailer Baugar, are parleying what they do for corporates, multi-nationals and financial institutions into a tool kit to help them fix the breakdown of entire finance ministries and the economies they run.

One restructuring boss who has been advising several governments said: “The game has moved on. Now it is not just companies, it is entire countries that
need our services. They need to be restructured and that will mean outside help.”

But some of the crews manning the lifeboats will include firms that prospered greatly in the days before the storm clouds had gathered and have themselves been partly blamed for causing the tempest.

Names such as Blackstone, Goldman Sachs, Credit Suisse and Deloitte who earned billions of pounds in the deal and debt frenzy are now at the
forefront of clearing up its aftermath.

Kari Hale, strategy partner at Deloitte’s, says that good advice could mean the difference between survival and going bust. Mr Hale was on the Anderson
team that along with McKinsey and Credit Suisse rode in to repair the systemic failure of the Swedish banking system in 1991.

Along with his boss at the time, Mark Carawan, who is now head of internal audit at Barclays, 70 senior partners at the three advisory powerhouses
spent 180 days tearing apart the financial structures of the Scandinavian state and rebuilding the entire system with a mandate for change and a
unified strategy.

The good bank/bad bank format they used in Sweden – like the current American TARP fund where the toxic debt of the likes of AIG and Lehman have
been dumped – became the template exported to other places where the IMF also lent money to, including Korea, Venezuela and Thailand.

But as the world economy grew and defaulting countries became a distant memory, the celebrated engineers of state administrations became redundant
and teams were closed down and the professionals moved to other more common place projects.

Now, the call has again been sounded and re-cast corporate fanciers, private equity principles and auditors are, with a gleam in their eyes, again making
up the rank and file of the restructuring world.

Blackstone, which advised Northern Rock in the run up to its nationalisation, was drafted into Iceland, where KPMG is also doing some work. Goldman Sachs advised the Treasury as it took over the ailing bank.

Amongst other European projects, the American private equity firm is working in the Ukraine alongside Credit Suisse, which has also seen its client list
grow with Government mandates such as Kazakhstan, Belgium and project based  work for the UK Treasury on RBS, Lloyds and HBOS.

Experts predict countries in freefall calling in the financial fixers or making deals with the IMF could include Latvia, Bulgaria, even Ireland, Greece and Italy.

At its inception in the 1940’s, the IMF was created up to help countries with bombed out balance sheets amidst the post-war yearning for a global
economic security. Representatives from 45 countries met in the town of Bretton Woods, New Hampshire in the United States and agreed on a framework for international co-operation to be set up after the Second World War.

Over the years it developed a special trust fund for low income countries lent money at 0.5pc interest rates to help reduce poverty and foster global
market stability.

But essentially, the IMF acts as a safety-net and insurance policy for its 185 member states. The members pay a subscription and at times of financial
crisis the IMF can offer medium term debt until a commercial solution can be arranged. It also sends out its economists to spot problems and early
warning signs of systemic economic failure.

 
The oil shock of the 1970s and South American inspired debt crisis of the 1980s led to sharp increases in IMF lending – including its biggest at the
time – a $3.9bn loan in 1976 to Jim Callaghan’s cash-strapped UK Government.

But in a world awash with cheap debt and exuberant trade surpluses, the Fund slipped from the forefront of the world stage and became regarded as at best
diminished and at worst irrelevant.

Only a year ago the IMF’s managing director Dominique Strauss-Kahn, a former finance minister in the French government and also a one-time presidential
candidate announced the fund had to cut up to 15 per cent of its workforce in a desperate attempt to sort out its finances as demand for its loans continued to weaken.

But now, thanks to a recent $100bn commitment from Japan, the Fund is sitting on more than $300bn ready to help rescue a dozen more countries that
could face default within the next few months.

There is increasing pressure on Middle Eastern countries to follow Japan’s example which has helped create a brand new short term liquidity facility.
Before this, the IMFs loans lasted five years. But the new product allows countries that are still fundamentally financially healthy but need quick access to cash to take out a three month loans at market rates. No money has been drawn from this facility yet but Turkey could be the
first.

Caroline Atkinson, an IMF director and part of the 24-strong management team of the institution, says the Fund has geared up at this time of
unprecedented financial crisis and could again start re-hiring, this time from the financial sector.

‘We are able to disburse money to applicant countries in just a matter of weeks if needed,’ says Atkinson. ‘We run very lean three to six person teams
that get into the crisis countries and negotiate funding packages directly with the government in very quick turn-around times,’ she said.

Mr Strauss-Kahn’s former colleague Simon Johnson – who a year ago was the IMFs chief economist, says: “There will be many many more countries out
there who will be calling on the IMF.

“They didn’t know it then but the world had drunk Kool-Aid. They believed the story that things would always be good and could only get better.”
Mr Johnson, now a senior fellow at the Peterson Institute and professor at MIT’s Sloane school of Management said: “There is a systemic shift in the
action the global economy needs,” he said. “And the IMF is best placed to deliver what is needed.”

 
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[return to index] [Action Ukraine Report (AUR) Monitoring Service]
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3.  UKRAINE SEEKS ADVISER IN CASE OF EARLY DEBT PAYMENT

Reuters, Kiev, Ukraine, Wednesday, December 3 2008

KIEV – Ukraine’s government wants to hire asset manager and equity fund Blackstone Group as a financial adviser particularly for talks on early repayment of state company debts, a senior official said on Wednesday.
“This is to do with issues such as servicing external debt, cabinet activity during the financial crisis, meaning financial policy, including consultations on talks with creditors, which want early repayment…,” First Deputy Prime Minister Oleksander Turchynov said after a cabinet meeting.
He said there was no issue over the government’s sovereign debt, but “unfortunately, state monopolies and state enterprises have such creditors”. He did not name which companies have been asked for early repayment, nor specified any amounts.
Ukrainian media reported last month that the state motorway firm Ukravtodor had been asked to pay off its debt early, but the company itself did not name a creditor nor an amount.
The state energy firm, Naftogaz, avoided default and possible early repayment of its $500 million Eurobond last month, when bondholders extended a deadline for receiving the company’s 2007 audited accounts to the end of the year.
Analysts have said that should Naftogaz default, clauses in its other debt agreements would force it to repay about $2.5 billion early. According to central bank data, Ukraine’s external debt as of July 1 stood at $42.7 billion, of which $38.5 billion was corporate debt. (Editing by Ron Askew) (Reporting by Natalya Zinets; writing by Sabina Zawadzki)
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[return to index] [Action Ukraine Report (AUR) Monitoring Service]
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4.  UKRAINE RESTRICTS BANK WITHDRAWALS TO AVERT LIQUIDITY CRISIS

By Kateryna Choursina, Bloomberg, New York, NY, Monday, December 8, 2008
KIEV – Ukraine’s central bank restricted withdrawals from banks before the maturity date of individual contracts to avert a liquidity crisis.
The Kiev-based Natsionalnyi Bank Ukrainy said in a letter to commercial lenders on Dec. 6 that early withdrawals of deposits “leaves liquidity of some banks under threat,” according to a statement on the bank’s Web site.
The central bank introduced a six-month moratorium for domestic lenders to return deposits to clients before contracts with banks that ended on Oct. 13 after depositors started withdrawing their money. Ukrainians were withdrawing as much as 2 billion hryvnia ($100 million) a day in the first days of October, First Deputy central bank Governor Anatoliy Shapovalov said on Oct. 24. The regulator also recommended that banks reduce foreign- currency interest rates, according to a statement on its Web site also dated Dec. 6.
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5.  UKRAINE INFLATION, EUROPE’S FASTEST, SLOWS TO 22.3% IN NOVEMBER

 
By Daryna Krasnolutska, Bloomberg, New York, NY, Sunday, December 7, 2008
KIEV – Ukraine’s inflation rate, the highest in Europe, fell in November for a sixth month, on slowing growth in food costs.  The annual rate dropped to 22.3 percent from 23.2 percent in the previous month, the state statistics committee in the capital Kiev said in a release on its Web site dated yesterday.
 
The median forecast of seven economists in a Bloomberg survey had been for a 22.6 percent rate. In the month, prices rose 1.5 percent, compared with 1.7 percent in October.
The government has to curb inflation to stabilize the economy and fulfill a pledge to the International Monetary Fund. The Washington-based lender agreed last month to provide $16.4 billion to the former Soviet republic to support its financial system, which has been battered by the global financial crisis, on condition it slows inflation to at least 17 percent next year.
The government raised its inflation forecast to “around 21” percent, compared with 15.9 percent initially expected for this year on Dec. 3. The government has failed to keep inflation below 10 percent since 2003.
Producer prices increased an annual 27.4 percent in November as compared with 37.7 percent in October. In the month, producer prices declined 6.5 percent as compared with a fall of 1.4 percent. Food prices rose an annual 26.7 percent in November, slowing from 29.4 percent in October.
 
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6.  UKRAINE GOVERNMENT WORSENS ECONOMIC PREDICTIONS

Deutsche Presse-Agentur, Kiev, Ukraine, Wednesday, Dec 3, 2008

KIEV – The Ukrainian government worsened official predictions for the economy on Wednesday, halving expected annual GDP growth for 2009 to between 3 and 4 per cent.

The former Soviet republic’s economy already has moved into a full recession, with GDP contracting 2 per cent during December alone, and annual
inflation standing at 21 per cent, a Ministry of Economy official said.

Ukraine’s Ministry of Economy as recently as June had been estimating that the country would over the course of 2008 see 7 per cent annual GDP growth,
and 15 per cent inflation.

Falling government revenues due to lower GDP growth had placed Ukraine’s 2009 state budget in jeopardy, and a budget review was ‘critical’ said Serhy
Romaniuk, Vice Economics Minister, at a Kiev press conference.

Ukraine’s pro-Europe government had for more than a month dragged its feet on even admitting the economy was teetering, with officials claiming
international economic weakness would leave Ukraine’s GDP growth and inflation numbers practically unchanged.

Political chaos making Ukraine’s leaders unable to deal with the crisis effectively was a key cause for the Kiev government’s unwillingness to admit
the economy was in trouble, observers said.

Ukraine’s parliament has been without a ruling coalition since September. Ukrainian President Viktor Yushchenko called for new elections to be held
December 15, but in-fighting between political factions and a state cash shortage has prevented Yushchenko’s administration from preparing for the
vote, and placed the poll in doubt.

Rewriting the national budget to take into account worsened economic performance was impossible, Romaniuk conceded, because the hung parliament
would be unable to consider new legislation, and due to the rapid weakening of the national currency, the hryvna.

Independent observers have for some time been pessimistic on the Ukrainian economy, with Fitch Ratings predicting Ukrainian 2008 GDP growth of 4.5 per cent, and inflation in excess of 25 per cent, according to an Interfax news agency report.
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7.  CURRENCY FALL REFLECTS UKRAINE’S WOES
Ukraine’s hryvnia has lost more than 60% from a peak of 4.50 to the U.S. dollar in the spring.

By Geoffrey Smith, The Wall Street Journal, New York, NY, Wed, Dec 3, 2008

KIEV, Ukraine — Ukraine’s currency spiraled to a new low Wednesday as data showed the country’s population ditching the hryvnia in favor of the dollar
faster than ever.

The former Soviet republic is entering a full-blown economic and financial crisis as global demand for steel, its main export, collapses, while Russia
continues to threaten it with an ever-higher bill for its gas imports. Confidence in the politically divided government’s crisis plan, which is backed by a $16.5 billion loan from the International Monetary Fund, is fading.

November data released by the National Bank of Ukraine showed it had already hemorrhaged almost 80% of the first part of the emergency IMF loan within a month of receiving it. The National Bank’s gross foreign reserves rose by only $820 million in the month to $32.74 billion, despite its receiving $4.5 billion from the IMF through a hastily arranged stand-by arrangement.

The central bank also said it spent $3.4 billion in foreign-exchange interventions in the course of the month to prop up the currency. From a peak of 4.50 to the U.S. dollar this spring, the hryvnia has lost more than 60%. The dollar surged to 7.51 hryvnia on the interbank market Wednesday, above the central bank’s official rate of 7.23.

The atmosphere at the country’s exchange booths has become increasingly tense in recent weeks, with many running out of foreign currency, first due
to the refusal of banks to comply with new central-bank regulations and then due to the sheer weight of demand. Net purchases of dollars by the
population more than doubled last month to $2.3 billion from $930 million in October.

Panic was further stoked by media reports earlier this week that President Viktor Yushchenko, onetime hero of the 2004 Orange Revolution, was preparing
a decree ordering the forced conversion of the population’s dollar deposits into hryvnia. Mr. Yushchenko denied the reports as “nonsense” Wednesday,
vowing he wouldn’t intervene in the central bank’s monetary policy.

However, his spokeswoman, Irina Vannikova, had told a briefing earlier this week that Mr. Yushchenko would take “extreme measures” against the NBU if it failed to bring the currency crisis under control. Her comments were widely taken at the time as a veiled threat to sack the central-bank’s chairman,
Volodymyr Stelmakh. (Write to Geoffrey Smith at geoffrey.smith@dowjones.com)\

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8.  NATIONAL BANK OF UKRAINE: STELMAKH COVERS UP BULLS AND BEARS  
 
By Serhij Lyamets, The Ekonomichna Pravda, in Ukrainian, Kyiv, Ukraine, Monday, Dec. 1, 2008
Action Ukraine Report (AUR), in English, Kyiv, Ukraine, Monday, December 8, 2008
 
It is the National Bank of Ukraine that provokes panic among Ukrainians and the crisis on the currency market by its actions, or rather the lack of actions.
Every week I get phone calls from the NBU. The central bank’s officials accuse me of destabilizing the banking system, notably, the currency market. “If the press wouldn’t give so much ink to the crisis, everything would be OK,” they tell me. 
Similar Statements emanate from many key banking system officials board, including the NBU board  chairman Petro Poroshenko and board member Vasyl Horbal. But now I know where the smoking gun is. 
In late October, I kept mum – not a single article on currency markets in the whole week. I really wanted to give the NBU a chance to put its business in order.
However, instead of harnessing the hryvnia-dollar exchange rate, NBU let it balloon to hryvnia 7.2 per 1 dollar, sending shock waves among Ukrainians.
Following this, let me tackle the issue from a different angle. Yes, the media write about the currency market problems, and this electrifies the populace. But, in the meantime, what are the actions of the NBU? What signals does it send to Ukrainians?
My answer is this: it is the National Bank of Ukraine that provokes panic among Ukrainians and the crisis on the currency market by its actions, or rather the lack of actions. The NBU appeals to Ukrainians not to buy greenbacks while pushing up daily the dollar exchange rate. How the NBU is doing this has been described many times. 
Let’s ask ourselves: “Why is the central bank doing this?” The NBU answer comes quick: “Because this is the market.”
Does it mean that we will put the blame for any lack of action on the market?
Question 2: “Who cashes in on the crisis?” According to NBU Governor Volodymyr Stelmakh, it is bears and bulls. “Who are these speculators? If they are owners of street exchange kiosks and underground centers for laundering money, where do they get the money from?”
It follows that the banks are the beneficiaries. And this is no mere rhetoric to smear the reputation of president’s buddy Volodymyr Stelmakh. 
It is the banks that sell dollars to exchange kiosks. It is the banks that tell their clients they are short of currency even to repay foreign loans. At the same time, it is the banks that keep foreign currency in their non-cash correspondence accounts. It is the banks that funnel heaps of greenbacks and euros to their cash desks. 
Hence, totally different questions come to mind. This one is for Mr Horbal: “Why did Ukrhazbank start selling dollars last week at 7.5 hryvnia? Is it your way to stabilize the currency market?
“Mr Poroshenko, why are you keeping mum about the list of banks that are the biggest buyers of dollars from the NBU?”
You have pledged publicly that you will get this information from the NBU board. Did you fail? Is everything ok and is there any graft on your turf ? If everything at the NBU is in top-notch order, how will you explain sudden interventions and restrictions imposed by the NBU on the sales of currency via auctions?
I also appeal to the Prosecutor General’s Office, Vekhovna Rada and the cabinet. Why did none of these structures lift their finger to check the validity of NBU board operations, and I mean to check the board activities, not to ask Stelmakh to explain the situation?
No one seems to care that the dollar costs 7.5 hryvnias, businesses are going bankrupt, and the number of bad credits is piling up.
Of course, most of my questions are for the NBU governor. “Mr Stelmakh, if you know who the bears and bulls are, why are you sitting on your hands? Or, probably, you intend to keep the status quo until 2010 [the year of the next presidential election]. Otherwise, Ukrainians will realize once again that they have been taken for a ride by the regime.”
Most importantly, Mr Stelmakh, why don’t your words tally with what is happening? Why does your deputy Oleksandr Savchenko make statements which are not implemented?
Let me now present my vision: judging by their declarations, NBU officials are after stability. In reality, however, their assurances of fighting the crisis are a smokescreen to hide a mechanism of bleeding the NBU of billions of dollars, with a specific group of individuals lining their pockets.
I would like to hear your comments, Mr. Governor.
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9.  UKRAINE’S CENTRAL BANK HELPS MAKE $23-BILLION DENT IN POCKETS OF UKRAINIANS

 
COMMENTARY & ANALYSIS: By Volodymyr Hrytsutenko
Professor of Current Ukrainian History, Lviv Franko University, Lviv, Ukraine
Action Ukraine Report (AUR), Kyiv, Ukraine, Monday, December 8, 2008
 
In early October, when the talk about the looming financial crisis was becoming loud in Ukraine, we heard soothing comments from National Bank of Ukraine officials and the finance minister. Strangely enough, while the dollar sank in the world, it surged in value in Ukraine. The officials said the rise of the dollar was only temporarily and the NBU would soon stabilize and strengthen the hryvnia.
It cannot be denied that, in part, the hryvnia devalued due to a severe political crisis, with the president and premier engaged in a cat-and-dog fight and the balkanized and stalled legislature bickering about the coalition. Becoming a weighty negative factor, such political goings-on contributed to fuelling domestic inflation and panic buying of hard currency by Ukrainians. 
Nonetheless, the NBU cited the ongoing financial crisis in the West as the basic cause of the hryvnia downfall. Not a word was spoken about the NBU share of the blame.
To explain the dollar surge, NBU governor’s chief advisor, Valery Lytvytsky, went on the air, saying the NBU is not guilty and the hryvnia rate of 7.3 to one dollar was too low. He said the fair exchange rate was Hr. 5.5-5.6 per $1.
He failed to explain, though, who or what stopped the NBU from selling dollars at this rate or why the rate was too low.
 
TRUE CAUSES OF HRYVNIA DOWNFALL
Meanwhile, the causes of the high dollar value can be seen with a naked eye.
The NBU did not sell dollars to all banks that asked for it, selling greenbacks only to the chosen few. It led commercial banks to buy the hard currency from other banks. Currently, the NBU provides credits to commercial banks at 8-12% interest rate. The banks, in their turn, give credits to legal entities at a staggering 25-30%, a killing rate for businesses. 
To shield itself from accusations, the NBU started sales of American currency: for example, while the banks applied for $433 million on Dec. 3, the NBU sold merely $93 million. On some days the NBU did not sell dollars at all, whipping up demand and panic even higher.  
The hryvnia downfall has been also caused by the large negative trade balance of Ukraine. Now that the national currency has devalued by almost 50%, many importers will be forced to stop to buy foreign goods and move into other areas of business. (There’s a silver lining, the low hryvnia will make Ukrainian exports more competitive.)
Even if Ukraine’s trade balance improves, it does not mean that the economy will recover. That is why financial experts predict a high exchange rate of 7.5 for $1 for the hryvnia (or even 8 according to the IMF forecast for 2009). Striking a pessimistic note, many bankers say it may take the hryvnia 3-5 years to recover to the 5.5 exchange rate.
As the demand for dollars dramatically exceeded the supply, the dollar value ballooned.
NBU AND YUSHCHENKO MUST TAKE THE BLAME
Many experts maintain that there were no real causes for the hryvnia downfall. The blame for it must be taken by the NBU and Pres Yushchenko as well as the cabinet for failing to react adequately to what the first two were doing.
 
When the dollar craze began in Ukraine, the country’s trade balance was the same as Armenia’s, Georgia’s, Moldova’s and Tadjikistan’s. Although some of these countries have even a worse trade balance, their national currencies were sinking by a mere 1.5-2% in a month.
 
A simple assumption can be made: by fanning inflation and forcing companies to go bankrupt, Ukrainian and other tycoons will soon be able to buy them up for a song. In what appears to be a well-orchestrated scenario, NBU Governor Stelmakh and NBU board members (P.Poroshenko, A. Kliuyev and others) handed out millions of hryvnias to their insider banks that launched a massive attack on the hryvnia.
In a telling example, the Ukrhazbank owned by Mr. Horbal, one of NBU board members, was selling dollars last week at a highly speculative rate of 7.5 hryvnia. Was it Mr Horbal’s way to stabilize the currency market?
HYPOCRITICAL MOVES BY PRESIDENT
The NBU has a lot of levers to rectify the situation but, strangely, it has not used them.  On Dec. 1, Viktor Yushchenko gave a stern warning to NBU Governor Stelmakh, saying he would fire him unless the hryvnia stabilized. The incumbent even specified the exchange rate of 5.8 to 5.9 per $1 he wants for the hryvnia. Nothing has happened ever since, neither the first nor the second. Result: Stelmakh is still NBU governor.
 
Now, as many new facts have surfaced, we see that the NBU cashed in on the financial slump, playing its own sinister role. The central bank wouldn’t have dared to behave so blatantly without a blessing from the highest office.
In a quite hypocritical move, Pres Yushchenko stated on Dec. 2 that there are no economic or financial grounds for the hryvnia devaluation. 
Commenting on the panic buying of dollars, he pinned the blame on the “psychological factor”, accusing the NBU and cabinet of being unable to cope with the panic among Ukrainians. 
Faced with a barrage of presidential criticism, Premier Yulia Tymoshenko dismissed accusations of inadequate reaction, stressing that, first, the NBU is not accountable to the cabinet under the Constitution, and, second, that Stelmakh is a close associate of Yushchenko and bringing him to heel was easy for the incumbent. 
 
LAWMAKERS THREATEN PROBE INTO NBU OPERATIONS
Meanwhile, Rada lawmakers have threatened to bring Stelmakh to account. Dec. 2, Anatoly Hrytsenko, head of VR committee on defense and security, proposed opening a criminal investigation into Volodymyr Stelmakh’s track record as NBU governor.  
In a related move, Regions lawmaker Mykola Azarov has publicly lashed out at the NBU and tabled a motion to create an investigation commission in parliament to examine the NBU activities. Given a negative assessment by the commission of his work, Stelmakh can be fired by the Rada without Yushchenko’s consent. 
“When NBU operations began to threaten hryvnia stability and the country’s financial system, lawmakers set up a work group to examine the NBU activities since the start of 2008. The group has reached a conclusion that there were not only blunders but also corrupt dealings and law violations,” Azarov stressed. 
 
It is becoming common knowledge in Ukraine that all personnel appointments by the president seem to have their concrete monetary dimension – in terms of kickbacks. A group of people have lined their pockets as a result of the hryvnia fluctuations. If the group’s profits were low, Stelmakh wouldn’t be governor of NBU.
 
This is the bottom line of what is happening around the Ukrainian currency. No doubt, like in the similar past hryvnia downfalls, in a couple of weeks the hryvnia will be stabilized, but the wallets of ordinary Ukrainians have already been made lighter by 160 billion hryvnia ($23 billion), Yury Kostenko said (incidentally, a loyal Yushchenko supporter), putting forward his Ukrainian People’s party demand to the incumbent to fire Stelmakh).   
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10.  TOUGH MEDICINE NEEDED FOR UKRAINE’S ECONOMIC WOES
 
COMMENTARY & ANALYSIS: By Volodymyr Lanovy
Radio Free Europe/Radio Liberty (RFE/RL), Prague, Czech Republic, Wed, Dec 03, 2008
 
The economic crisis in Ukraine has become a reality: enterprises are halting production, bank branches are going into liquidation, employees are being laid off. It is hard to remember that as recently as three months ago economic-development indicators were steadily rising. One has the impression the country has been swept up in an unexpected tsunami.

The metaphor is apt, even though to a considerable extent the crisis crept into the homes of average Ukrainians bit by bit. In the first half of this year, interest rates soared and the hitherto stable value of the hryvnya was shaken. Investments in the economy dried up, and the construction sector slowed down.

But an economic tsunami did roll over us from the outside. And its effects were hard felt in Ukraine, a country that is neither among the high-technology countries of the West nor among the oil-and-gas giants of the East. Like most countries in the world, Ukraine is between the former and the latter and seems to have been hit from both sides.

First, Ukraine — like all the other countries of the world — has become an unwilling financial donor to a void that opened up in the United States. The outflow of capital from our country has resulted in a catastrophic plunge of the stock-market indexes and an abrupt decapitalization of Ukrainian enterprises. By contrast, the U.S. markets have seemed virtually stable.

Second, Ukraine — like many Western countries — was vulnerable because the economy had been weakened by inflated global prices for oil and gas. Before the crisis struck, Ukraine was de facto a major contributor to the Stabilization Fund in Russia. Kyiv had no opportunity to build up its own reserves like Russia, many Persian Gulf energy producers, China, and other countries were able to do. Now those countries have funds to provide assistance to their own banks and companies and even to offer credit to Western countries. Ukraine is left to compete with other countries for help from the International Monetary Fund or to cope on its own.

Third, Ukraine’s economy was relatively weak even before the crisis struck. It is already in its second year of a rapidly rising trade deficit and a negative hard-currency-payments balance. This situation meant that the halt of foreign-capital inflows brought on by the crisis has struck the national currency hard, producing a sharp decline in production and consumption.

Fourth, the slowdown of commodities markets abroad means a decrease in orders for Ukrainian industrial and agricultural products, decreases in the prices for key exports, and sharp losses for major enterprises.

MAJOR REFORM NEEDED 

Clearly, Ukraine’s recovery plan must extend beyond merely addressing the immediate effects of the crisis. Ukraine must not only cover financial deficits and credits, but it must also recover the position of its enterprises on global markets and ensure that production is sufficient for domestic demand.
 
A recovery program should include both immediate, extraordinary measures to counter various financial implosions and a complex of structural and institutional reforms, without which we will be unable to compete in today’s globalized and pitiless world.

Over the long term, global economics will come down to a struggle among countries for a share in the global investment flow. Therefore, it is essential that our national anticrisis program include reforms that will make Ukraine a worthy competitor in this struggle.

Ukraine must improve its hard-currency, credit, and investment markets. They must be deregulated, transparent, accessible to everyone globally, and protected against administrative interventions.

It must implement far-reaching tax reform to reduce corporate and individual taxes, while also introducing mandatory contributions to the state’s pension, insurance, and environmental funds. It should impose taxes on real estate and the consumption of energy and natural resources.

Kyiv must reform the stock exchange to protect the rights of minority shareholders, mandate transparency in corporate accounting and reporting, and introduce online trading. It must create investment banks and encourage public share offerings. It must adopt a broad program of demonopolization and credible antimonopoly regulation.

It must introduce market-oriented reforms of key sectors that remain under state control: the fuel and energy complex, agriculture, machine building, transport, road management, telecommunications, housing and utilities, and others. The country must also face the fact that its management system is shortsighted, cumbersome, onerous, and inefficient.

Yes, there is work to be done.

NOTE: Volodymyr Lanovy was Ukraine’s economy minister and first deputy prime minister in 1992 and head of the State Property Fund in 1997-98. The views expressed in this commentary are the author’s own and do not necessarily reflect those of RFE/RL.

 
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11.  MARS UKRAINE JOINS U.S.-UKRAINE BUSINESS COUNCIL (USUBC)

Confectionery, food, beverage, health & nutrition, pet care products company. USUBC member 98.
 
U.S.-Ukraine Business Council (USUBC), Washington, D.C., Tue, Dec 2, 2008

WASHINGTON, D.C. – Mars Ukraine has been approved for USUBC membership, according to the USUBC executive committee, in an announcement on behalf of the entire USUBC membership. Mars Ukraine is USUBC member ninety-eight. 
 
Mars, Incorporated is a family owned company, with six industry leading business units – Chocolate, Petcare, Food,  Drinks, Symbioscience and now Wrigley Gum and Sugar. Headquartered in McLean, Virginia, Mars, Incorporated operates in more than 79 countries.

 
With the addition of Wrigley, a recognized leader in confections with a wide range of product offerings including gum, mints, hard and chewy candies, lollipops, and chocolate, Mars has grown from approximately 50,000 to 65,000 associates worldwide and from $22 billion to $28 billion in annual
revenue.
The combination of Mars and Wrigley brings together two strong, international businesses and creates one of the world’s leading confectionery companies. The portfolio spans a variety of categories such as confectionary items, main meals, side dishes, beverages, snack foods, frozen snacks, organic foods, pet foods, and now also includes Wrigley’s vast portfolio of gum brands and sugar items.
 
Founded in 1911, Mars manufactures and markets a variety of products under many of the world’s most recognizable trademarks, including DOVE®, MILKY WAY®, M&M’S®, SNICKERS®, MARS®, UNCLE BEN’S® Rice, ROYAL CANIN®, PEDIGREE® and WHISKAS® pet care products, STARBURST®, SKITTLES®.
DENIS YAROTSKY, GENERAL MANAGER, MARS UKRAINE
Denis has started his successful career with Mars back in 2001 as Marketing Manager. His last position before coming to Ukraine was the CIS Snackfood Marketing Director, member of Management Team, in Moscow. Denis started as General Manager of Mars Ukraine in March 2008 when his predecessor Robert John Woodcraft retired. Denis will represent Mars Ukraine on the USUBC board of directors.
 
Mars started operations in Ukraine 14 years ago. It was a representative office until year 2004 when full fledged business operations were established. Since that time Mars Ukraine has become one of the fastest growing FMCG companies in the country. Today Mars Ukraine is undisputed leader in both categories where it competes: Chocolate Bars and Pet Care. In Ukraine Mars is present with its global brands M&M’S®, SNICKERS®, PEDIGREE®, WHISKAS®.
Mars Ukraine plans to build a large pet food plant in Ukraine.  However various legislation issues in Ukraine have made it difficult for businesses to pursue these plans.
 
PURCHASES WM. WRIGLEY JR. COMPANY
Mars, Incorporated (“Mars”) announced recently it has successfully completed its acquisition of the Wm. Wrigley Jr. Company (“Wrigley”), following approval of the transaction by Wrigley stockholders on September 25, 2008 and receipt of all necessary regulatory approvals.
The Wm. Wrigley Jr. Company is a recognized leader in confections with a wide range of product offerings including gum, mints, hard and chewy candies, lollipops, and chocolate. The company distributes its world-famous brands in more than 180 countries.
 
Three of these brands – Wrigley’s Spearmint®, Juicy Fruit®, and Altoids® – have heritages stretching back more than a century. Other well-loved brands include Doublemint®, Life Savers®, Big Red®, Boomer®, Pim Pom®, Winterfresh®, Extra®, Freedent®, Hubba Bubba®, Orbit®, Excel®, Creme Savers®, Eclipse®, Airwaves®, Solano®, Sugus®, P.K.®, Cool Air® and 5™.
For additional information about Mars please visit their website: www.mars.com
 
“USUBC is very pleased to have Mars Ukraine, as a new member” said Morgan Williams, SigmaBleyzer, who serves as president of USUBC.  “USUBC has grown very rapidly during the past 22 months and now has a membership base which allows USUBC to provide its members such as Mars Ukraine with a full-time operation and a significantly expanded program of work,” according to president Williams.
 
USUBC MEMBERSHIP WILL TOP 100 IN 2008
Mars Ukraine is the 48th new member for 2008, and the 78th new member since January of 2007. USUBC membership has quadrupled in the past 24 months, going from 22 members in January of 2007 to 98 members in December of 2008. Membership is expected to top 100 this year.
 
The new USUBC members in 2008 include MaxWell USA, Baker and McKenzie law firm, Och-Ziff Capital Management Group, Dipol Chemical International, MJA Asset Management, General Dynamics, Lockheed Martin, Halliburton, DLA Piper law firm, EPAM Systems, DHL International Ukraine, Air Tractor, Inc., Magisters law firm, Ernst & Young, Umbra LLC., US PolyTech LLC, Vision TV LLC, Crumpton Group, Standard Chartered Bank, TNK-BP Commerce LLC, Rakotis, American Councils for International Education, Squire, Sanders & Dempsey LLP, International Commerce Corporation, and IMTC-MEI.
 
Additional new USUBC members in 2008 are: Nationwide Equipment Company, First International Resources, the Doheny Global Group, Foyil Securities, KPMG, Asters law firm, Solid Team LLC, R & J Trading International, Vasil Kisil & Partners law firm, AeroSvit Ukrainian Airlines, Anemone Green Capital Limited, ContourGlobal, Winner Imports LLC (Ford, Jaguar, Land Rover, Volvo, Porsche), 3M, Edelman, CEC Government Relations RZB Finance LLC (Raiffeisen), IBM Ukraine, SoftServe Inc., The Washington Group (TWG), SE Raelin/Cajo, Inc., AnaCom, Inc., Pratt & Whitney – Paton and
Mars Ukraine.
 
The complete USUBC membership list and additional information about USUBC can be found at: http://www.usubc.org.
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12.  UKRAINE: IMB GROUP BEING REBRANDED, ALLOCATES $100 MILLION
FOR ACQUISITION OF UKRAINIAN BANKS WITH WORLD BANK’S SUPPORT
 
IMB Group, Kyiv, Ukraine, Wednesday, November 12, 2008

KYIV – IMB Group (Public) Limited, a parent company of International Mortgage Bank and Family Credit ™, a leader of the Ukrainian consumer loan market, last week made the decision to update its strategy.

 
The key elements of a new strategy will include a rapid growth in short-term retail loans, including consumer (installment) loans, cash loans and credit cards, attraction of deposits and discontinuance of mortgage lending. As a part of the new strategy, the company also plans to deal with consolidation of the Ukrainian banking sector.
 
To achieve these goals, the company will allocate a total of $100 million both in its own capital and in credit lines from the International Finance Corporation, a member of the World Bank Group. To implement the new strategy, the IMB Group (Public) Limited companies will be incorporated under new brands: PLATINUM BANK (previously – International Mortgage Bank and Family Credit™) and PLATINUM HOLDING (previously – IMB Group).
Greg Krasnov, CEO of PLATINUM HOLDING, said: “Today, our bank is the most highly capitalized and liquid bank in Ukraine. This excessive liquidity can be used to support the Ukrainian banking sector. At the same time, we can speed up implementation of the new strategy through acquisition of banks that experience problems with liquidity. Such use of the long-term debt is going to be more efficient than further development of the mortgage business, whose investment attractiveness has declined substantially due to the financial crisis.
 
“The consolidation rationale is also supported by the fact that our international management team has a strong know-how in the banking industry, including the crisis management and integration areas. We are pleased that our shareholders, including World Bank, support the new strategy and are ready to provide additional capital for its implementation.”
The company plans to implement rebranding during the 1st quarter of 2009. When screening banks for acquisition, in the first place, the company will assess the potential of the existing retail network of the banks under consideration, including the existing retail deposit base. The consolidation strategy will be primarily focused on medium banks with a deposit base of UAH250 million to UAH1 billion.
NOTE: Platinum Holding (previously – IMB Group) is a 100% parent company of Platinum Bank (which was previously known as International Mortgage Bank and operated under the Family Credit trade mark), a leader of the Ukrainian retail loan market. Platinum Bank offers consumer loans, cash loans, credit cards and deposits through a broad network of branches and customer service points throughout the country.
 
As of September 30, 2008, consolidated assets of Platinum Holding amounted to UAH1.142 billion, while its equity capital was UAH736 million and its long-term credit lines were UAH363 million. In terms of the consolidated equity capital, Platinum Holding ranks 10th in the rating of Ukrainian banks.
 
Major shareholders of Platinum Holding include international private equity funds such as Horizon Capital, Warburg Pincus, East Capital, Goldman Sachs, as well as the International Finance Corporation (a member of the World Bank Group) and the management. The company’s partners in long-term debt funding include Western government agencies such as the International Finance Corporation, the Overseas Private Investment Corporation (USA), the European Bank for Reconstruction and Development, and FMO (the Netherlands.)
 
NOTE:  Horizon Capital is a member of the U.S.-Ukraine Business Council (USUBC), Washington, D.C., www.usubc.org.

LINK: http://www.horizoncapital.com.ua/files/press_2008/press_release/Press%20Release_IMB%20Group_Eng.pdf

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13.  EPAM SYSTEMS ADVANCES TO 190TH PLACE WITHIN THE LIST
OF WORLD’S 500 LARGEST SOFTWARE AND SERVICE PROVIDERS

EPAM Systems, Lawrenceville, New Jersey, Monday, December 1, 2008

LAWRENCEVILLE, NJ – EPAM Systems, Inc. , the leading software engineering and IT Outsourcing (ITO) provider with delivery centers in Central and
Eastern Europe (CEE), announced today that it has advanced to the 190th place on Software Magazine’s annual ranking of the world’s 500 largest
software and service providers — The Software 500.

EPAM is proud to be named on the prestigious The Software 500 list along with 29 of its ISV (Independent Software Vendors) clients, ranging from
promising start-ups to global software leaders including three of the Top 10 honorees on the list.

Since its inception in 1993, EPAM has enabled ISVs and other technology focused organizations to build, maintain and support world-class software
products.

Today, utilizing the talent and experience of thousands of engineers located in advanced development centers across Central and Eastern Europe, EPAM
covers the complete software development lifecycle from research to prototyping and development, testing, deployment, maintenance and support for variety of products including world’s leading ERP and eCommerce applications as well as specialized embedded software that controls some of the most sophisticated electronic devices.

In addition EPAM offers its unique ability to deliver complex distributed professional services including architecture level consulting, product
customization, porting and cross-platform migration, as well as deployment of mission critical enterprise level highly customized solutions built on
top of the standard product functionality.

“We would like to congratulate our 29 ISV clients who made this year’s list. We extend our thanks for the opportunity we have enjoyed to grow together
and to leverage each other’s strengths,” commented Arkadiy Dobkin, EPAM’s President and CEO, noting: “We are also confident that many of our younger,
but nevertheless innovative and fast growing clients will make the list in coming years.”

ABOUT DIGITAL SOFTWARE MAGAZINE, THE SOFTWARE

DECISION JOURNAL AND SOFTWAREMAG.COM
The Software 500 is a revenue-based ranking of the world’s largest software and services suppliers targeting medium to large enterprises, their IT
professionals, software developers and business managers involved in software and services purchasing.

According to the results of the survey, the software industry continues to grow in total revenue, representing growth of 14.7% from the previous year,
while the total employee growth rate of 1.3% shows modest increase compared to 2007. “The Software 500 helps CIOs, senior IT managers and IT staff
research and create the short list of business partners,” said John P. Desmond, Editor of Software Magazine and softwaremag.com.

Digital Software Magazine, the Software Decision Journal, has been a brand name in the high-tech industry for 30 years. Softwaremag.com, its Web
counterpart, is the online catalog to enterprise software and the home of the Software 500 ranking of the world’s largest software and services companies, now in its 26th year. Software Magazine and Softwaremag.com are owned and operated by King Content Co., www.softwaremag.com.

ABOUT EPAM SYSTEMS
Established in 1993, EPAM Systems, Inc. is the leading global software engineering and IT consulting provider with delivery centers throughout Central and Eastern Europe (CEE). Headquartered in the United States and serving clients worldwide, EPAM provides software development and IT related
services through its more than 4,500 professionals deployed across client delivery centers in Russia, Belarus, Hungary, and Ukraine.

EPAM’s core competencies include complex software product engineering for leading global software and technology vendors, as well as development,
testing, maintenance, and support of mission critical business applications and vertically oriented IT consulting services for global Fortune 2000
corporations.

EPAM is ranked among the top companies in IAOP’s “The 2008 Global Outsourcing 100” and in “2007 Top 50 Best Managed Outsourcing Vendors” by
Brown-Wilson Group’s Black Book of Outsourcing. Global Services Magazine recognized EPAM in its “2008 Global Services 100” list as the No.1 company in the “Emerging European Markets” and included EPAM into the global Top 10
“Best Performing IT Services Providers” .

For more information on EPAM Systems, Inc., please visit www.epam.com. For further information contact Alena Busko, Marketing Manager
EPAM Systems, Delivering Excellence in Software Engineering, Office phone: +1 (609) 613-4031, ext. 50474, E-mail: press@epam.com.

NOTE:  EPAM Systems is a member of the U.S.-Ukraine Business Council (USUBC), Washington, D.C., www.usubc.org.
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14.  UKRAINE’S THREAT REDUCTION PROGRAM SUPPORTED BY U.S.
NOW SUPPORTED BY $37 MILLION SUB-CONTRACT FROM BLACK
& VEATCH TO SOUTHERN RESEARCH INSTITUTE
 
Southern Research Institute, Birmingham, Alabama, Monday, December 1, 2008
BIRMINGHAM, Ala.  – Southern Research Institute, a not-for-profit scientific organization that conducts basic and applied research in the areas of preclinical drug discovery and development, advanced engineering, environmental and energy production, today announced that it has been awarded a subcontract from Black & Veatch [Kansas City, MO, USA] to support the U.S. Department of Defense’s Biological Threat Reduction Program (BTRP) in Ukraine.
The award is expected to generate up to $37 million in revenues for Southern Research over the next five years. “We are honored that Black & Veatch has selected our Southern Research team to provide support for such an important global program,” said John A. “Jack” Secrist III, Ph.D., president and CEO of Southern Research Institute.
 
“Working with Black & Veatch on the Ukraine task order will allow Southern Research to not only contribute to the safety and well-being of the United States, but to use our knowledge and expertise for global safety as well.”
As the prime integrating contractor, Black & Veatch will design, engineer and deploy systems, processes and technologies to further strengthen reporting, detection and response capabilities. Southern Research will provide a wide range of scientific consulting in the design and implementation of modern diagnostic laboratories throughout the Ukraine.
Additionally, Southern Research will facilitate collaborative research projects conducted by US-Ukraine interdisciplinary teams. The Southern Research biological threat reduction program will be managed by Mary Guttieri, Ph.D., based in Washington DC, in conjunction with William Severson, Ph.D. and Colleen B. Jonsson Ph.D. based in Birmingham, Ala.
The Defense Threat Reduction Agency (DTRA), the BTRP’s implementer, awarded Black & Veatch, a leading global engineering consulting and construction company, one of the agency’s major Biological Threat Reduction Integrating Contracts (BTRIC), with a collective ceiling of $4 billion over 10 years among the five selected contractors.
 
As part of the BTRIC, Black & Veatch was selected and awarded the first task order in Ukraine valued at more than $175 million during an initial five-year timeframe to include options.
The task order includes enhancing the Ukraine’s existing network of human and veterinary diagnostic laboratories that handle especially dangerous pathogens.
 
It also involves strengthening biosafety and biosecurity measures to combat bioterrorism and prevent the proliferation of biological weapons-related technology, pathogens, and expertise while enhancing the government’s existing disease surveillance systems to detect and report bioterrorism attacks, epidemics and potential pandemics.
ABOUT DTRA 
DTRA safeguards the United States and its allies from weapons of mass destruction (chemical, biological, radiological, nuclear and high explosives) by providing capabilities to reduce, eliminate and counter the threat and mitigate its effects. This combat support agency serves as the intellectual, technical, and operational leader for the Department of Defense in the national effort to combat weapons of mass destruction. Established in 1998, this year DTRA celebrates 10 years of creative solutions through teamwork.
ABOUT BLACK & VEATCH 
Black & Veatch is a leading global engineering, consulting and construction company specializing in infrastructure development in energy, water, telecommunications, and management consulting, federal and environmental markets. Founded in 1915, Black & Veatch develops tailored infrastructure solutions that meet clients’ needs and provide sustainable benefits.
Solutions are provided from the broad line of service expertise available within Black & Veatch, including conceptual and preliminary engineering services, engineering design, procurement, construction, financial management, asset management, program management, construction management, environmental, security design and consulting, management consulting and infrastructure planning. With $3.2 billion in annual revenue, the employee-owned company has more than 100 offices worldwide and has completed projects in more than 100 countries on six continents. The company’s Web site address is www.bv.com.
 
ABOUT SOUTHERN RESEARCH 
Southern Research Institute is a nonprofit 501(c)(3) scientific research organization that conducts basic research in drug discovery for cancer, emerging infectious diseases, and diseases of the central nervous system; contract preclinical drug and vaccine development, and advanced engineering research in materials, systems development, environment and energy.
Our more than 600 scientific and engineering team members support clients and partners in the pharmaceutical, biotechnology, defense, aerospace, environmental and energy industries. Southern Research is headquartered in Birmingham, Ala., with facilities also located in Wilsonville, Ala., Anniston, Ala., Frederick, Md., Durham, NC, and Fort Leonard Wood, Mo.
 
For more information about Southern Research and its capabilities and accomplishments, visit www.SouthernResearch.org
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15.  WHERE EAST MEETS WEST: EUROPEAN GAS AND UKRAINIAN REALITY 

 

By Edward Chow and Jonathan Elkind, The Washington Quarterly, pp. 77 – 93
Journal of the Center for Strategic and International Studies (CSIS), Washington, D.C., January, 2009
 
NOTE: Edward Chow and Jonathan Elkind have written an article in the January 2009 issue of The Washington Quarterly.  The article, entitled “Where East Meets West: European Gas and Ukrainian Reality,” explains how Ukraine is caught between the old, post-Soviet world and the new, European one that it desperately wants to join. By focusing on Ukraine’s natural gas industry, the authors have highlighted the dilemmas facing Ukraine and Europe, as it reconsiders Ukraine’s bid to join the European security community. 
 
Edward Chow is a senior fellow in the CSIS Energy and National Security program and a former international oil industry executive. He can be reached at EChow@csis.org. Jonathan Elkind is a nonresident senior fellow at the Brookings Institution and previously served on the staff at the National Security Council. He can be reached at jelkind@brookings.edu.
 
WHERE EAST MEETS WEST: EUROPEAN GAS AND UKRAINIAN REALITY
Ukraine is caught between the old post-Soviet world and the new, European one
 
On January 11, 2008, on the eve of the NATO summit meeting in Bucharest, the Ukrainian president, prime minister, and parliamentary speaker wrote to Secretary General Jaap de Hoop Scheffer, asking that Ukraine be invited to begin a Membership Action Plan (MAP) leading to membership in the Alliance. (1) In April, the NATO heads of state deferred the issue of MAP for Ukraine, and fellow aspirant Georgia, saying that progress should be assessed at the December 2008 NATO ministerial. (2)  In that same month, after a tumultuous year of political recriminations and policy deadlock within the ruling coalition, Ukraine is also scheduled, to have its third pre-term parliamentary election in three years.
These events shine a harsh spotlight on the current policymaking environment in Kyiv, and also on the country’s longstanding aspiration to join the Euro-
Atlantic community. At present, Ukraine is caught between the old, post-Soviet world and the new, European one that it says it wants to join. Nowhere is this clearer and more consequential, both for Ukraine and for the Euro-Atlantic community, than in Ukraine’s natural gas industry.
 
While Ukraine plays a critical role as the key transit connection between gas producers in Russia as well as Central Asia and gas consumers in the EU, its incomplete market economic transition and culture of corruption weaken its own energy security, destabilize its economy, destroy public trust in its politics, and undermine the interests of its European neighbors as well.
Worse yet, Ukraine’s leverage in the energy marketplace is eroding rapidly. A Ukraine that modernizes the practices in its energy sector can contribute significantly to European security, stability, and economic prosperity. Yet, this is not the role that Ukraine has played since 1991 and, even most disappointingly, not the role the country has played since the dramatic Orange Revolution brought new leaders to power in 2005.
 
Western leaders who have encouraged Ukraine’s Euro-Atlantic aspirations would be well-advised to examine critically the current state of Ukraine’s gas sector, its implications for the country’s democratic development, and risks for European security as it considers Ukraine’s bid to join the trans-Atlantic community in 2009 and beyond.
UKRAINE’S ABUNDANT ENERGY POTENTIAL 
Ukraine’s corruption and incomplete economic transition weaken its own energy security – and Europe’s
Ukraine’s energy situation is much more complicated and perilous than it should be. The country has a generous endowment of hydrocarbon resources both
onshore and offshore in the Black Sea. It has a capable energy workforce, and long experience in the exploration, production, transportation, and refining of
oil and gas. Most prominently, it is strategically located and has large-scale infrastructure.
Today, roughly 80 percent of the gas being exported from Russia to Europe crosses Ukrainian territory, roughly 120 billion cubic meters (bcm) per year.
This gas originates variously in Russia and Central Asia, and it passes Ukraine en route to European clients who are the best-paying customers of the Russian gas titan, OAO Gazprom.
 
In fact, two-thirds of Gazprom’s revenue comes from the sale of gas that crosses Ukraine, which in turn represents more than 20 percent of growing European gas demand. Moreover, Ukrainian gas throughput can be increased by 25 percent, to roughly 150 bcm per year, on a cost-effective basis, with comparatively modest capital investment relative to all other alternatives.
 
Ukraine also has strategic strength in the form of other energy transportation infrastructure. Its oil pipeline network can transmit roughly one million barrels  of oil per day (nearly 7 percent of total EU demand) to central and eastern European destinations. It also has immense gas storage capacity. The country can store up to 35 bcm of gas (roughly 40 percent of Germany’s annual demand) in underground gas storage systems, which are mainly located in the west of the country – an ideal location for serving European gas customers. Gas storage is a particularly valuable asset because it allows one to match supply, which is basically constant year-round, and demand, which often varies widely due to seasonal changes or other commercial or even strategic factors.
As for its domestic energy production, Ukraine has several hydrocarbon producing provinces onshore and has vast geological potential both on and
offshore. Peak historical gas production was 68.7 bcm in 1975 (more than the total consumption of Germany, Italy, and the United Kingdom  at that time), compared to the current production level of 20 bcm.
 
Today there are opportunities for enhanced oil and gas recovery from Soviet-era fields plus previously untapped ”greenfield” opportunities, especially in deeper producing zones and in the Black Sea. Industry experts, both inside and outside Ukraine, commonly believe that with improvements in the overall investment climate and with the right changes to the legal and regulatory environment, Ukraine could double its gas production within a decade.
ENDURING ENERGY INSECURITY 
Ukraine’s gas sector presents risks for European security.
Roughly 80 percent of gas exported from Russia to Europe crosses Ukrainian territory.

Despite this resource potential, strategic location, and existing infrastructure, the country struggles with energy security. The reasons are an incomplete transition to market economics, chronic underinvestment, and profound opaqueness of policymaking, which fuels corruption.
Seventeen years after the break-up of the Soviet Union, the energy economy of independent Ukraine is still frozen in seemingly permanent transition. The
structure of the energy sector, particularly of the oil and gas industry, is a cross between a Soviet branch ministry and private interest groups. The state-owned company, NAK Naftohaz Ukrainy, contains many able and knowledgeable professionals but is overly politicized in leadership, overstaffed, mismanaged, impoverished, and operates under numerous fundamental conflicts of interest.
For example, one of the company’s wholly-owned subsidiaries, UkrTransNafta, operates the country’s oil pipelines and is responsible for determining the  terms on which domestic crude oil is accepted into the system for transportation, including from private oil companies that have invested in exploration and
production (E&P) activities. At the same time, other Naftohaz subsidiaries, some of which have controlling private owners despite being predominantly
state-owned, are also in the business of extracting crude oil. Naftohaz’s subsidiary UkrTransNafta, therefore, is determining pipeline access for private E&P investors even as they compete with other Naftohaz subsidiaries.
Price signals, the most fundamental element of a functioning market, are also profoundly confused and obscured in the Ukrainian energy sector. For example, in its current form, the gas industry employs multi-tier pricing that reduces incentives to conserve a precious resource and enables flourishing graymarket trading.
 
In other words, gas from domestic Ukrainian production is theoretically earmarked for use by residential customers and government-funded organizations at a subsidized price, while higher priced imported gas is meant to be used for industrial consumption. Not surprisingly, this schema is not honored in reality. Politically well-connected individuals and companies use barter arrangements and re-export schemes to profit handsomely while injuring the national welfare. Meanwhile, domestic gas production is depressed by artificially low prices.
Non-transparency reaches its peak in international natural gas trade and transit, where the poster child is the shady middleman, RosUkrEnergo (RUE). The company’s role is a political bone of contention in that an entity with no assets, no track record, and no transparency was placed at the very center of the
Ukrainian gas economy.
 
Moreover, RUE did not even have to compete for this very lucrative position. It is also important to note that RUE was not the first mysterious middleman to operate in the Ukrainian gas sector. One therefore wonders: if RUE is thrown out, as the most senior Ukrainian officials have said they would like to do, would RUE simply be replaced by another nontransparent entity despite all declared policy to the contrary for supply contracts with Gazprom and Central Asian gas producers?
Similar to its predecessors Itera and EuralTransGaz (ETG), RUE makes a fortune by re-selling gas in Ukraine and in neighboring central European
countries which has been imported from, or transported across, Russian territory. Under the January 2006 gas agreement, Ukraine pays RUE in kind by giving it more than 20 percent of the total delivered gas, which is 15 bcm of the 73 bcm that were nominally contracted for 2007.
 
The value of the in-kind gas in late 2007 was $4.35 billion, assuming a gas price of $290 per thousand cubic meters which was a representative price in central and eastern Europe at the time. Today, the value of this gas would be substantially higher, based on prevailing prices for gas. According to numerous press reports and industry rumors, RUE’s ample profits flow into the pockets of well-placed officials in the Russian and Ukrainian gas industries and governmental structures.
The Ukrainian oil and gas sector is dominated, some would say strangled, by parties that control investment decisions and cash flows, but who are not subject to the responsibility of ownership. Typically, company owners must comply with transparent government regulation and must exercise discipline in their operations to deliver financial performance for fear of being rejected by the capital markets on which the company depends. Instead, the parties who control the Ukrainian oil and gas sector use their positions to block development, to extract economic rent, and to pick commercial winners and losers for their personal convenience.
 
For example, only some projects get governmental approvals; only some companies get sought after contracts. Consequently, control over the sector is a major prize in political contests. When one political bloc is uppermost in national politics, no project proceeds without the blessing of, and benefits for, people connected with that bloc. When that group loses the political upper hand, deals are often subject to renegotiation. At the same time, it becomes the job of each successive political opposition to block all policy proposals, even the sensible ones, because the opposition is not profiting. As a result, few major long-term policy initiatives have been enacted or implemented.
One of the most damaging results of this pattern is chronic underinvestment in the oil and gas sector. Opportunities to raise production, increase efficiency,
and improve reliability are lost because short investment horizons dominate. In infrastructure-dependent, capital-intensive, long lead-time industries like oil and gas, such actions severely damage the prospects for progress and development. Consequently, the condition of Ukraine’s oil and gas industry continues to deteriorate.
 
In May 2007, for example, one of the main gas transmission lines near Kyiv experienced a failure and exploded. Had the accident occurred in the winter, when cold temperatures hike demand and when all gas pipelines operate  at peak levels, the incident could have had a major humanitarian impact. Instead, it only signaled the risks of underinvestment in operations, maintenance, and upgrades.
Ukraine consumes between approximately 60 and 75 bcm annually, which makes it the sixth largest gas consumer in the world, with consumption levels
that are completely out of proportion to the size of its economy. (3)  Its consumption equals that of all the Visegrad countries – Czech Republic, Hungary, Poland, and Slovakia – combined. Its energy intensity is not only higher than Western European countries, but it is twice as high, or twice as
inefficient, as neighboring Poland. Ukrainian officials and lawmakers make ritualistic comments about the need to reduce energy intensity, but the extent of
real action is very limited.
MISSED OPPORTUNITIES 
Three years after the Orange Revolution, the gas sector is no more transparent that it was.

In the wake of the 2005 Orange Revolution, President Viktor Yushchenko and Prime Minister Yulia Tymoshenko declared high ambitions for energy sector
reform, increasing public expectations. Three years later, none of the stated intentions and expectations has been met. Most conspicuously, the gas sector
remains as convoluted and impenetrable as ever. In March 2005, Yushchenko declared that gas trade with Russia would be conducted on a cash basis rather than through non-transparent in-kind payments.
 
Yet, no proper negotiation process followed. Throughout the fourth quarter of 2005, tensions over the gas issue grew, and both Russia and Ukraine resorted to the gas equivalent of saberrattling. The Russians’ version of this high-stakes brinksmanship was to threaten to cut off gas supply to Ukraine. The Ukrainian version was to threaten to stop gas transit to Europe.
On January 1, 2006, Russia’s Gazprom reduced gas through put to Ukraine by an amount roughly equivalent to what Ukraine would have been entitled to
extract if a contract were in place. In the midst of a bitterly cold winter throughout Europe, Ukraine apparently retaliated by taking unsanctioned gas from the pipeline system. Foreign governments, especially in Europe and the United States, reacted quickly, criticizing the Russian cut-off and calling for the
two sides to reach a negotiated settlement. Early on January 3, Russia returned the gas pipelines to normal operations, appearing to concede that it had lost the battle for international public opinion.
On January 4, Naftohaz Chairman Oleksiy Ivchenko and Ukrainian Minister of Fuels and Energy Ivan Plachkov announced a new gas agreement with
Gazprom and RUE. To those who had been monitoring the mounting crisis, the agreement was as incomprehensible in its logic as it was unprofessional in its form. Regrettably, it also established the pattern for two subsequent years of negotiations. The result of the early 2006 negotiations was unfavorable to
Ukraine inasmuch as it gave away the previously-agreed nominal gas price of $50 per thousand cubic meters and accepted a nominal price of $95.
 
In exchange for this concession, Ukraine did not receive an agreed pricing formula for future years, which would have removed the opportunity for politically-charged eleventh-hour negotiations. Nor did Ukraine receive agreement on a period for transition to higher prices or a long-term, ship-or-pay volume guarantee from the Russian side, nor any other enforceable contract provisions. Instead, the RUE import monopoly was expanded, and its non-transparent in-kind payment further entrenched.
Late in 2006, under a new government led by Prime Minister Viktor Yanukovich of the Party of Regions, Ukraine accepted a nominal price of $130 per thousand cubic meters for 2007. Late in 2008, the nominal price rose to $179.50, again without normal international contract protections. During the
same period, both Belarus and Bulgaria successfully negotiated multi-year gas supply agreements with pricing mechanisms and multi-year periods for transition to ”European” pricing levels with Russia.
 
Neither of these countries has negotiating leverage comparable to Ukraine’s, leverage which reflects the fact that 120 bcm of gas transit Ukraine annually from Russia to European consumers. For reasons that are inexplicable as a matter of basic negotiating leverage, Ukraine failed to secure self-protection that less powerful neighbors managed to secure with Gazprom.
Ukraine claims to receive gas, while Russia claims to sell gas, at nominal prices that do not correspond with reality. These nominal prices have deceived
the Ukrainian public into thinking they were getting a better deal than they are, and have created a disincentive to engage in gas sector modernization, a faulty logic that is based on the fear that Ukraine could not survive economically if it were required to pay European gas prices. False prices and faulty contract compliance also allowed the Russian side to accumulate debt obligations from Ukrainian entities, thus setting the stage for predatory buy-outs by entities with the right connections (whether Russian, Ukrainian, or other).
The mechanism used to mask these false prices is simple. According to the terms of the January 2006 agreement, Ukraine pays a stated price (initially $95 per thousand cubic meters, then $130 for 2007, and $179.50 for 2008) to import up to 58 bcm of gas per year (roughly three-quarters of Ukrainian
demand). To receive that volume of gas for domestic use, Ukraine must actually buy 73 bcm of gas, out of which 15 bcm is transferred to RUE for the ”service” of delivering the total volume of gas to Ukraine. As a result, the actual price paid  by Ukraine is significantly higher than the nominal price, since approximately one of every five cubic meters that Ukraine purchased (15 of 73 bcm) is actually being turned over to RUE, with its beneficial owners pocketing the handsome profits.
In 2007, gas was selling in several central and Western European countries for around $290 per thousand cubic meters on a delivered basis.4 In that same year, Ukraine paid the nominal price of $130 per thousand cubic meters for 56 bcm of gas that was said to be sourced from Central Asia, and Ukraine paid $230 for a further 17 bcm that was said to be sourced from Russia. In aggregate, Ukraine paid $11.19 billion for 73 bcm in 2007.  
 
In exchange for that aggregate sum, Ukraine actually received only 56 bcm of gas for its own consumption, making the price Ukraine effectively paid in 2007 for each thousand cubic meter of the usable gas $192.93, not $130. Similarly, the real price in 2008 that corresponds to the nominal price of $179.50 is roughly $240 per thousand cubic meters. For RUE, this arrangement has been exceptionally lucrative. RUE has been able to re-sell at European market value the gas it receives as an in-kind transfer.
 
Certain Ukrainian industrial and export customers are willing to pay close to full value, which means that RUE can pocket literally billions of dollars per year.5 The reason behind RUE’s preferential place in the Eurasian gas trade has never been explained in comprehensible terms. Gazprom and Russian government officials have always blamed the Ukrainians while the Ukrainians have always blamed the Russians.
 
Nonetheless, the simple fact is that Gazprom allowed billions of dollars of value to flow into the pockets of a group of middlemen without demonstrable industry expertise and without compensating Gazprom’s shareholders, or Russian taxpayers, in any commensurate way. And the Ukrainian government and Naftohaz allowed RUE to occupy an absolutely central place in the Ukrainian economy, earning billions from the role, without ever having had to compete for the role or prove its capabilities in any way.
From time to time since 2005, Ukrainian officials have proudly asserted that they have extemporized skillfully, allowing their country to buy time and adjust gradually to higher gas prices. Unfortunately, such claims ring hollow. Three years after the arrival of Yushchenko and the Orange forces, the gas sector is no more transparent than it was in 2004, when RUE’s role was more limited. As of 2008, Ukraine still lacks the stability and predictability that would come from long-term gas contracts.
 
Ukraine also lacks the protections that would come from an international-style agreement that includes all the standard provisions that Gazprom routinely negotiates and concludes with its German, French, or central European counterparties -provisions such as take-or-pay obligations for gas buyers, ship-or-pay obligations for shippers, price adjustment mechanisms, clear arbitration provisions, and many more.
Over the past three years, Ukraine’s negotiating leverage has eroded greatly.
Gazprom is three years closer to its objective of commissioning bypass pipelines that will allow it to transport more of its gas to Europe without having to cross Ukraine. Blue Stream, which passes under the Black Sea to Turkey, is operating at capacity while Nord Stream, which is meant to cross the Baltic to Germany, is proceeding, though not without a number of headaches. And South Stream, which is planned to pass under the Black Sea to Bulgaria, is now under development. All three of these routes will bypass Ukraine entirely.
 
Even without these pipelines being completed, Ukraine’s leverage is rapidly eroding. Naftogaz’s chronic and massive indebtedness – it is currently in
technical default of its international bond obligations – makes Gazprom the only potential purchaser of its remaining valuable assets, namely the trunk gas
pipeline and storage facilities. Gazprom’s dominant position gives Russia the possibility of taking over Ukraine’s decaying infrastructure and strengthening its control over gas exports to Europe, including those from Central Asia, even without having to construct all the bypass pipelines it is planning.
Although gas trade and transit carries the greatest international impact, they are not the only parts of the Ukrainian energy sector that remain distorted and
dysfunctional. Domestic production is stagnant to declining at the time when it should be booming. Investment in exploration and production of Ukraine’s oil and gas resources, which could have been substantial at a time of historically high international prices and constrained access to new prospects, has amounted to a trickle at best.
The sole international competitive bidding for new development that occurred in this entire period, for the Prikerchenskiy offshore block in the Black Sea, has been a classic case of non-transparency, rent-seeking, and professional incompetence. First, in 2005, Ukrainian officials deliberately chose not to employ standard marketing techniques that are universally recognized as proven approaches to increase industry awareness of new prospects, and thus
increase potential bids from competing companies. Then in 2006, with the country experiencing political turmoil associated with imminent parliamentary
elections, bids were collected under an ill-conceived process, and a small independent American oil company with modest experience in offshore west
Africa, Vanco, was announced the tender winner.
In late 2007, with yet another new Ukrainian government about to arrive, the terms of the production sharing agreement (PSA) were concluded and
formalized by the outgoing government. The timing struck knowledgeable industry observers as unusual, a long-term deal concluded in haste by a lameduck
government just before its departure. Most observers assumed the deal would be overturned by an incoming government, and unfortunately they were
proven right.
 
In May 2008, it was officially revealed that Vanco’s Pricherchenskiy investor group includes the Ukrainian firm Donbass Fuel and Energy
Complex (DTEK), which is owned by Ukraine’s richest man, Rinat Akhmetov, the force behind the now-out-of-power Regions Party of Ukraine, as well as
other mysterious entities whose ownership and expertise have never been revealed.
 
The second Tymoshenko government, in turn, cancelled Vanco’s license, allegedly due to problems in the fairness and adequacy of the tender process and  license terms, which then led to an open disagreement between Yushchenko and Tymoshenko. In the summer of 2008, Vanco announced it would take the matter to international arbitration. The deputy head of the presidential secretariat stated to the press: ”We do not have the right to revoke the license unilaterally.” (6)
 
This entire experience calls into question Ukraine’s interest in attracting transparent foreign investment into its upstream oil and gas industry. Despite
numerous efforts, no major foreign investor has been able to achieve any success in Ukraine’s upstream oil and gas sector, including Royal Dutch Shell and
Marathon.
 
The nature of the current investment climate should ring alarm bells in the ears of Ukrainian policymakers along with the leaders of the Euro-
Atlantic community. If developing the country’s domestic hydrocarbon resources is a priority for Ukraine, as it should be, and if foreign investment is
essential to the country’s ability to develop those resources in a timely manner, and it is, then it is important to acknowledge that, at present, the investment
climate of Ukraine is highly unattractive.
IMPROVING UKRAINE’S OIL AND GAS SECTOR
In the long run, energy production, transportation, and distribution need to be unbundled.
 
Currently, Ukraine’s oil and gas sector is being operated in a completely dysfunctional manner. Yet, there are several beneficiaries, well-positioned
individuals and key political forces, milking the energy sector, particularly the oil and gas industry, for personal enrichment and as sources for  political funds. The present state of affairs underscores the most essential prerequisite for change in Ukraine’s oil and gas sector: political will. The needs of the nation, for today and tomorrow, are consistently overridden by short-term political expediency and personal gain, creating a corrosive effect on the entire political system, as it contributes to a broad loss of faith in the political process among the Ukrainian public.
 
The open and free press that has exposed the corruption underlying the oil and gas industry, however, is one of the truly important and hopefully lasting changes after the Orange Revolution. Today’s energy policy, which serves the interests of certain political elites rather than the country, poses imminent danger to the nation, yet it is not being addressed with any sense of urgency. To date, no political faction has demonstrated a willingness to put aside parochial interests for the good of the nation, a reality that must be changed if Ukraine is to pursue membership in the Euro-Atlantic community.
As experience around the globe will attest, sound energy policymaking is a difficult task. The United States, and many other political cultures that are far
more settled than Ukraine, struggle to make good choices in energy policy. Effective energy policy requires political leadership, economic analysis, public
dialogue, consensus building, commercial awareness, planning, and professional execution, not the enunciation of lofty goals.
 
Energy policy should be based on sound priorities, action plans, intermediate objectives, and realistic timetables. At present, Ukrainian officials betray a lack of seriousness on energy strategy, which undercuts the ability of commercial and public decision makers to plan energy-related aspects of their future, and reinforces already high public cynicism about the mishandling of the energy sector.
Gas supply and transit, which have been the source of so much controversy and intrigue since Ukrainian independence, must form the core of a sound
Ukrainian energy strategy. Ukraine could credibly set the goal of reducing its reliance on imported gas from the current level of approximately 75 percent to
50 percent within the next five to seven years. Achieving this objective would require a range of efforts, some related to domestic supply and some to demand.
 
On the demand side, there is great scope for helping Ukrainians, particularly those living in multi-family apartment buildings, to simultaneously reduce their gas consumption and improve their comfort as well as quality of life by investing in energy efficiency. Another essential aspect of this initiative would be to reduce gas consumption by allowing gas prices to increase to full-cost recovery levels and by enforcing payment discipline. This is important because allowing the accumulation of gas debts only makes Ukraine vulnerable to highly disadvantageous debt-equity swaps.
In addition to reducing gas consumption, Ukraine could increase its domestic gas production. Eliminating multi-tiered pricing would encourage new domestic production, because domestic production is currently designated for sale to residential and budgetary-institution consumers, but at only a fraction of the true market value. The current practice discourages domestic production and subsidizes higher-priced imports.
For gas transit, Ukraine’s goal should focus on stabilizing its contractual relationship with Russia. At present, Ukrainian officials constantly declare that
their country is a reliable transit partner, but a short conversation with virtually any European gas industry executive will reveal that this self-perception does not correspond to the understanding of industry experts outside Ukraine. Nearly seventeen years of post-Soviet experience have taught Europeans that Ukraine is the part of the supply chain that often leads to disputes, mutual recriminations, and endless charges and counters charges. It is the weak link.
 
It is hardly surprising that many Europeans conclude that it is better to pay lip-service to the idea of closer gas-related engagement with Ukraine rather than formulate policies that would lead to such engagement. At present, because of the legacy of Soviet-style gas contracts, Ukraine is Russia’s problem to  manage. And Europe does not appear to object to this reality.
Ukraine can transform its reputation by developing policies that aim to improve its reliability as a transit partner. A first step would be to engage in a
systematic internationally-sanctioned assessment of the condition and investment requirements of the Ukrainian international gas transit system (IGTS).
The assessment could identify opportunities to increase operating efficiency and reduce bottlenecks, serving as the basis for increasing Ukraine’s transit revenue by increasing throughput volume, and not by extorting higher transit tariffs as is often proposed by Ukrainian officials. Such a technical audit would be welcome and possibly funded by the donor community. Needed capital improvements can be financed by international credit according to modern business standards.
 
Ukrainian officials often complain that transit across their country is substantially less expensive than across many other European countries which occupy a far less strategic position in the supply chain, a fact borne out by analysis conducted by the Energy Charter Secretariat, among others. Transit across Ukraine, however, comes with an uncertainty premium that the market is no longer willing to bear. Ukraine would be better advised to build market confidence and increase its transit revenues by increasing volume first and only later by increasing transit fees if such increases can be justified by investments to improve reliability and increase capacity in the Ukrainian IGTS.
FIVE STEPS TO ENERGY SECTOR STABILITY 
The essential prerequisite for change in Ukraine’s oil and gas sector is political will.
To achieve the priorities outlined above, Kyiv can take five steps that will help stabilize Ukraine’s energy sector.
 
[1] First, Ukraine should seriously and professionally negotiate with Russia to reach new long-term agreements on gas supply and transit. At this writing, representatives of Naftohaz and the Government of Ukraine continue to negotiate with Russian officials and Gazprom over a future,  multi-year gas agreement and a gas price for 2009. Senior officials from the presidential secretariat and the Tymoshenko government continue to use the gas issue as a cudgel to attack each other in hopes of scoring political points.
 
This is not only unproductive for the country but is also damaging efforts that aim to improve Ukraine’s reputation as a serious and reliable transit country. It is not clear from press reports whether Ukrainian representatives are pursuing a clear negotiating strategy that is informed by expert analysis and supported by duly experienced professionals in fields such as international business practice, law, and finance, or are simply building on old and inefficient policies and practices. In any case, it is hard to imagine why Russia would agree to a firm contract prior to the upcoming, pre-term parliamentary election in Ukraine. Yet, Ukraine’s winter gas supply and Europe’s gas imports depend on agreements that expire on December 31, 2008.
[2] Second, Ukraine needs to transform the state-owned company Naftohaz into a functioning commercial concern. Naftohaz dominates the Ukrainian oil and gas industry in the style of a Soviet branch ministry, and consequently simply hemorrhages money. The fact that Naftohaz remains dominant, despite its
consistent financial losses, reflects a conscious dual choice on the part of successive rounds of Ukrainian legislators, cabinets, prime ministers, and
presidents: first, the choice not to address the utter insolvency of the oil and gas sector and, second, the choice to engage in asset-stripping and rent-seeking.
Naftohaz is on the brink of bankruptcy due to the absence of necessary and crucial reforms in areas like gas pricing. The company is responsible for buying gas for the needs of Ukraine’s population, governments, and some industry, but is unable to collect payment from consumers in amounts sufficient to replace the consumed gas and operate the delivery system. As a result, Naftohaz’s finances have reached the breaking point. It borrows expensively in the debt markets, paying a high premium because of its non-transparent business practices and precarious financial position, and uses the funds for current operations instead of capital improvements.
 
The cycle repeats until Naftohaz is declared to be on the verge of bankruptcy, at which point the government finally steps in and bails out the company, declaring it to be too important to fail. The government then changes absolutely nothing in the way Naftohaz operates, and the whole corrupted process starts over again. Naftohaz received a bailout in early 2008 as the current government entered office but went right back to losing money hand over fist. By summer, a new bailout was already under discussion, and by early October, a new bailout priced at $1.7 billion was announced. (7) Unfortunately, there is no reason to believe that the pattern will not repeat itself yet again.
To end this vicious cycle, Naftohaz must be subjected to fiscal discipline. It needs to be able to charge its customers nothing less than the actual cost of the
delivered fuel. In addition, Naftohaz and all its lenders must be informed that there will be no further government bailouts of the company. Naftohaz’s
operations must be rid of non-core functions, and inherent conflicts among the various Naftohaz functions must be resolved once and for all. In the long run, the essential functions of energy production, transportation, and distribution will need to be unbundled, consistent with European reform efforts, and with
creating a competitive market. In short, Naftohaz must be transformed so that it is no longer a big black hole.
[3] Third, RUE and other middleman firms must be removed. These firms impose a hidden cost not only on Ukraine but also on Russian taxpayers and Gazprom shareholders. RUE also introduces serious risks and instability into the European  gas supply chain. In late April 2008, press reports about a possible new Ukrainian-Russian gas deal indicated that RUE was to be removed, with all wholesale gas to be purchased by Naftohaz while independent gas traders would serve the intermediary function between Naftohaz and end users. Depending on In the long run, energy production, transportation, and
distribution need to be unbundled. implementation, this arrangement could open opportunities for new intermediary companies to establish themselves in the same way as RUE and others did, with all the attendant risks that are discussed above.
[4] Fourth, Ukraine should promote efficiency by reforming pricing and helping consumers use less gas. The danger in multi-tier wholesale gas pricing
is that domestically-produced gas, which is nominally designated for public and household consumption, may get sold on the gray market to domestic industrial users or export buyers who are willing to pay European prices. These illicit sales fuel corruption and muffle the market signal that would otherwise promote increased domestic production and decreased consumption. Serious pricing reform is required – based on a sensible, transparent, and easily understandable rate methodology that allows gas producers or sellers to recoup their costs plus a reasonable rate of return.
Price formation will require capable and independent regulators to operate in a publicly transparent fashion so that the interests of producers and consumers are adequately balanced and duly protected. Price reform will mean higher prices all across the Ukrainian economy, which means the potential for negative impacts on the poor, namely those least able to pay higher prices. In order to lessen the impact on the poor, Ukraine should follow the example of other eastern and central European countries that have already undergone price reform.
 
Energy efficiency programs can help reduce the energy consumption of residential and institutional buildings as a first priority. Lending programs can be created, expanded, or strengthened to allow Ukrainian industry to borrow money in order to invest in upgrades for plants and equipment. And targeted assistance can be introduced to alleviate the burden on those legitimately unable to pay. The current system unfortunately operates in the interest of well-connected gas consumers and penalizes the poor who suffer shortages – making reform a necessity.
[5] Finally, Ukraine needs to improve its investment climate for exploration and production of hydrocarbons. If natural resource endowments were the only relevant factor, Ukraine would be able to produce significantly greater quantities of oil and gas than it does today. Significant improvement to the business climate, however, is required to attract the investment of billions of dollars needed for serious upstream development. Ukrainian energy legislation and regulation will need to be updated to correspond with norms found elsewhere around the globe.
 
The updated system will need to provide for fair access to geologic data, transparent decision making processes, longer licensing periods, use of model contracts, and truly competitive tenders. In other words, almost all of today’s standard practices, which are optimized for insiders and those paying for inside access, would need to be replaced. This will take time. Meanwhile, Ukraine will need a success story or a demonstration case that can prove the country’s new political will to encourage upstream investment.
THE KEY TO EURO-ATLANTIC ASPIRATIONS 
 
Ukraine is a country generously endowed with many assets. Its well-educated population of 46 million, industrial and technological prowess, huge agricultural potential, and cultural wealth all make it a natural candidate for the Euro-Atlantic community, if that is the wish of its people. The current form of the country’s energy sector, however, needs to be seen for what it is, a major threat to itself and to its neighbors. If Ukraine fails to modernize its energy sector practices, the sector will continue to undermine Ukrainian politics, economy, and energy security. Most importantly, it will threaten Europe’s own  energy security.
Ukraine has the potential to change this story line. Friendly governments and international institutions can help with capacity building for effective policy
execution, but only after the political will for energy reform is in place. Serious energy sector reform would not only help Ukraine but would also stabilize the economic undergirding of all European gas importing countries.
 
In this sense, serious energy reform would arguably be Ukraine’s single most important contribution to improve the security of the trans-Atlantic community. On the other hand, continuing failure to engage in energy reform, when the high stakes are so obvious to all, would be a clear signal that Ukraine is not ready to pursue its stated desire of becoming a more integral part of the Euro-Atlantic community.
 
NOTES:
1. Press Office of President Viktor Yushchenko, ”Joint Address to NATO Secretary General”, January 11, 2008, http://www.president.gov.ua/en/news/8645.html.
2. Bucharest Summit Declaration, April 3, 2008, http://www.nato.int/docu/pr/2008/p08-049e.html.
3. Gas consumption figures drawn from the BP Statistical Review of World Energy 2008, available at http://www.bp.com/productlanding.do?categoryId6929&contentId7044622. GDP figures are purchasing power parity estimates, drawn from CIA’s World Factbook, available at https://www.cia.gov/library/publications/the-world-factbook/index.html.
4. To compare (in a rough manner) the price of gas delivered to a given European country X and the price of gas delivered to Ukraine, one needs to subtract from the gas price in country X the price of transit from Ukraine’s eastern border to country X. For example, in January 2007 Russian gas delivered to France cost on the order of $295 per thousand cubic meters. If one deducts gas costs of transit between Russia and France, the comparable price in Ukraine would have been roughly $230. This is only an indicative comparison and should not be interpreted as implying that there is a standard or an ”accepted” gas price in Europe. Gas prices under a given contract reflect the full range of factors from competitive gas supply to quantity of demand, and from available alternative fuels to skill of the commercial negotiators.
5. Since Ukrainian regulators never based their rate-making calculations on the actual price of gas (rather, they used the nominal price for their calculations) Ukrainian customers never paid the actual replacement cost of the gas they consumed. This fact allowed debt to pile up, which then provided the basis for more non-transparent deals.
6. ”Ukraine president suspends cabinet’s decision to control top state companies,” BBC Monitoring Kiev Unit, May 20, 2008.
7. Alexander Bor, ”Ukraine Orders $1.7 billion Naftogaz Bailout,” Platts Oilgram News 86, no. 198 (October 7, 2008): 7.
 
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