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Analysis & Opinion
24.11.09 One Step Back, Two Steps Forward
By Tom Balmforth

On November 19, the likelihood of a gas conflict between Ukraine and Russia at the end of this year appeared to have been significantly reduced after Prime Minister Vladimir Putin made a key concession on gas trade at a meeting with his Ukrainian counterpart Yulia Tymoshenko in Yalta. Tymoshenko, a front-runner in the Ukrainian presidential race, walked away from the deal looking good. But analysts say that fundamental problems, such as Ukraine’s domestic gas policy, still remain a potentially explosive flashpoint in Russia-Ukraine gas relations in the near future.

The Ukrainian economy has been battered by the financial crisis and Ukraine has subsequently found it particularly hard to meet its contractual obligations to Russia’s state-owned gas monopoly Gazprom. Vastly reduced gas consumption during the economic crisis has meant that Ukraine has fallen short of its consumption quota for gas in 2009, making it eligible for sizeable sanctions in line with its “take or pay” style gas contract. Russia has now, however, agreed to waive these fines. Moreover, at the meeting in Yalta Putin promised that Gazprom would agree to set a new volume of gas to be exported to Ukraine in 2010, taking the currently reduced demand into account. “We sincerely expect that all earlier reached agreements will be implemented, and from our side we guarantee full implementation,” Reuters quoted Putin as saying at a news conference after the deal was struck. “It would be nice to see a New Year without any shocks,” he added.

The deal will bring a sigh of relief from the millions of Europeans who were left shivering in January this year after disagreement between Ukraine and Russia resulted in a temporary disruption in gas supply. Roughly a fifth of Europe’s gas arrives from Russia through Ukraine’s transit network. Past conflicts over gas between Ukraine and Russia have prompted temporary cessations in gas delivery to Europe, often around January, when contracts between Russia and Ukraine are due for renegotiation. This year, political instability in the run up to Ukraine’s approaching presidential elections, slated for January 17, has made conflict over gas into a real worry.

But after Russia’s concession was agreed, there seemed to be a sense of optimism. “Without any doubt, removing the ‘take or pay’ obligations in the contract is good for Ukraine,” said Pierre No?l, a research fellow for energy issues at the European Council for Foreign Relations. “If Ukraine is able to buy less gas next year, that will be a great help to Ukraine’s beleaguered budget,” said Andrew Wilson, a senior policy fellow at the European Council on Foreign Relations and senior lecturer of Ukrainian studies at the School of Slavonic and Eastern European Studies. “I think removing the ‘take or pay’ obligation obviously makes the contract much more favorable to Ukraine in the longer-term, in the sense that, even if gas consumption never really recovers, or recovers really slowly, they still do not have to worry about that,” said No?l.

But still, “Europe is just crossing its fingers,” said No?l. “There is a sense of relief. But you just hope it’s justified.” A gas row this year, or early next, remains a real possibility, because “the risk of a conflict in the coming weeks is more linked to the ability of Ukraine to pay for its gas in the short-term than to the structure of the contract,” he added. And Ukraine’s current economic health is extremely poor. When on November 11, the International Monetary Fund (IMF) announced that it would not be releasing a $3.8 billion bailout earmarked for Ukraine, Tymoshenko recognized that Ukraine was entering an “extremely difficult” period. Putin followed the news up with tough rhetoric underlining that Russia would once again turn off the taps to Ukraine if it fails to pay for its gas on time, or else siphons off gas destined for Europe. “The fact that Ukraine messed up its agreement with the IMF clearly increases the risk that it will not be able to pay,” said No?l.

One reason Ukraine struggles to afford its gas imports is because it sells imported gas to consumers at a cheap rate. “Ukraine has always paid for its gas by borrowing one way or another. They seem to be structurally unable to charge the gas to consumers in Ukraine at a price that reflects the price they pay Gazprom. This is unsustainable. It is a recipe for a crisis and at some point they won’t be able to borrow any more,” said No?l. “Obviously, politically it is very difficult. But so long as I don’t see the price of gas in Ukraine reflecting the import price, I will be worried about the Ukraine-Russia gas relationship. Even if you take the politics and geopolitics aside, it is simply not possible to buy large quantities of gas at a price that you don’t charge to your customers. It’s as simple as that,” he said.

So, why did Russia make this concession to Ukraine? On the one hand there is a clear economic rationale to the deal. “The reality is that Ukraine’s gas contract had probably become impossible to honor exactly as it was signed. So it’s just adapting to reality - all contracts do that. Of course they were less high-profile negotiations, but after all Russia agreed to drastically reduce the ‘take or pay’ obligations of its European contracts during the last month. So after doing that with France, Germany, Italy, then why not Ukraine?” said No?l.

Politically speaking, the deal with Russia also served to promote Tymoshenko’s candidacy for president, at the expense of the current President Viktor Yushchenko’s. As Wilson said, after the agreement was reached, “it does now seem that Putin’s personal favorite is Tymoshenko.” Yushchenko’s pro-Western policies have made him extremely unpopular amongst Russia’s political establishment, and when on November 19 he appealed to the Kremlin for a revised gas deal in an open letter, he was simply snubbed, which made Tymoshenko look even better when she won a concession from Putin. “Tymoshenko’s smile [after the deal] is not at all surprising,” said Wilson.

Beyond this, however, there was no clear indication of Russia working a secondary political agenda, because Russia has no reason to rock the boat. With Yushchenko’s popularity rating languishing around the five percent mark (scarcely in the frame for a president), Russia has little political stake in another conflict over gas, analysts said. “It wouldn’t be in Russia’s interest to have a gas row where it couldn’t control the consequences, given that it seems to be happy with either [front-runners] Viktor Yanukovich or Tymoshenko for president. Yushchenko is polling so low at the moment that there don’t seem to be any political incentives to have another row,” Wilson noted.
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