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Analysis & Opinion
30.04.10 Does Russia’s Gas-For-Fleet Swap With Ukraine Make Strategic Sense And Will It Stand?
Comment by Vladimir Frolov

Contributors: Vladimir Belaeff, Stephen Blank, Ethan S. Burger, Vlad Ivanenko, Nicolai Petro

Russia’s President Dmitry Medvedev made his first official visit to Ukraine last week to sign a landmark agreement with Ukraine’s new President Viktor Yanukovich to extend the Russian Black Sea Fleet’s lease on the port of Sevastopol for another 25 years in exchange for a significant reduction in natural gas prices for Ukraine. Under the terms of the deal, Russia’s Gazprom will sell gas to Ukraine’s Naftogaz at a 30 percent discount from current prices for ten years. The price reduction, estimated at about three to four billion dollars, will be achieved by cutting Russian export duties, and thus will not eat into Gazprom’s profits.

In an accounting gimmick, the annual discount on natural gas will count against the higher rent payments for the Russian naval base at Sevastopol. That arrangement is written into the naval lease agreement itself that was ratified by the Russian Duma and Ukranian Rada on the same day, April 27. Any move by future governments of Ukraine to terminate the naval lease agreement with Russia would simultaneously terminate the gas price reduction.

The deal will save Ukraine about $40 billion over the next decade, returning many Ukrainian steel and chemical companies to profitability while lifting the pressure on Ukraine’s state budget.

Russia, in turn, is getting long-term predictability over the future of its Black Sea fleet (the new agreement will allow Moscow to introduce new combat ships to the fleet, making it a more modern and viable force), as well as what appears to be a 30-year veto on Ukraine’s foreign and security policy.

It is clear that the new agreement precludes Ukraine’s membership in NATO in the foreseeable future and closely links Ukraine to Russia’s security agenda in Europe. In fact, President Medvedev specifically referred to the deal as a contribution to his vision of the European Comprehensive Security System.

The fleet-for-gas swap is expensive for Russia, costing the state budget over three billion dollars a year, but geopolitically it ensures vital Russian security interests. It also saves Moscow the expense of building a new naval base at the unsuitable and inhospitable harbor of Novorossiysk.

The deal will also pave the way for Russian acquisitions in Ukraine’s energy sector and will secure uninterrupted Russian gas transit to Europe through Ukraine’s pipeline network.

For Ukraine’s new President Viktor Yanukovich the agreement on extending the naval lease with Russia could prove politically divisive. Former President Viktor Yushchenko’s Our Ukraine party has called for the impeachment of President Yanukovich for breaching his oath to defend the Constitution (which bans foreign military bases on Ukrainian territory). Yulia Tymoshenko’s party has called for an emergency session of Parliament and has vowed to block the treaty’s ratification.

Still, many Ukrainians welcomed Yanukovich’s decision to exchange naval basing rights for gas. Eighteen percent of those questioned in a poll last month by the Research & Branding Group, a Ukrainian pollster, had no objection to the base staying after the expiration of the 1997 treaty, and 43 percent said they would not object to the fleet staying on if Russia gave Ukraine economic preferences, while just 22 percent wanted the fleet to pull out of Ukraine in 2017. Such numbers give Yanukovich some political space to push the new agreement through.

Will the new agreement benefit the interests of Ukraine and Russia? Is it another case of Russia using its “energy weapon” to secure geopolitical objectives? Is Russia paying more than it should be for its naval presence in Ukraine? How will the base lease extension affect the future of Crimea and its predominantly Russian population? Will it strengthen the case for Crimea’s secession from Ukraine? How will the new deal affect European security? How will it affect Gazprom’s strategy in Europe? Will it help avoid the gas supply disruptions that plagued Russia’s relations with Europe under the previous government in Ukraine? How will it affect NATO and its decision to make NATO membership available for Ukraine? Should the West welcome or oppose this deal between Russia and Ukraine?

Vlad Ivanenko Ph.D., Ottawa:

The emphasis in examining Russia’s investments in Ukraine, and I have no doubt that the latest accord belongs to the field of political investment decisions, should be on its long-term, or strategic, consequences. Vladimir is right to present a long list of relevant questions, but the format of expert’s submission allows us to address only a few of them.

In general terms, Russia is interested in Ukraine increasing its weight in international affairs. The integration of the post-Soviet space under Russian leadership increases the bargaining power of the country vis-?-vis the rest of the world, be it in the influence that the new union would wield in global organizations, or the greater monopoly of power it could exercise in international trade. Ukrainian interests appear to be less strategic in nature, as its leaders’ top concern is to get the economy moving forward in configuration with whichever external power they can get economic cooperation from.

Currently, the best offer comes from Russia. However, it doesn’t mean Russia is overpaying, as the reduction of natural gas prices for Ukraine is more in the nature of a force majeure than a real subsidy. The market of natural gas is passing through a period of transformation. Demand in Europe is stagnating if not falling and it is the first time in many years that Gazprom has had to reduce production not because of supply constraints, but supply glut. Certainly, the Russian government has shown a degree of goodwill in improving the terms of trade in Ukraine’s favor, but it does so sensing the downward pressure on the price of natural gas everywhere else (this is also a bad news for Azerbaijan and Turkmenistan).

Regarding the extension of the naval base lease in Sevastopol, not being an expert in military affairs I can add nothing. However, it seems to send a powerful signal of goodwill on the part of the Ukrainian elite, which is a significant development economically. It indicates that the country is now prepared to speed up the process of integration among former Soviet republics that was stalled by former President Viktor Yushchenko's administration. If so, other agreements should follow this one.

In a paper published in 2006, I argued that Ukraine could dominate certain markets in the post-Soviet space, such as food production and metallurgy, if its elite agreed with other Eurasian countries on the division of gains resulting from such cooperation. Such gains would come through exploiting the economies of scale associated with larger markets and avoiding competition for outside customers that tends to reduce revenue. However, to ensure that the profits are not appropriated by one state at the expense of another, Russia and Ukraine should initiate reciprocal exchanges of control over their national “champions.” The next test of trust between the elites of the two countries would be announcement of joint ventures or, even, mergers between such major Russian and Ukrainian firms as Naftogaz and Gazprom or Industrial Union of Donbass and one of Russian metallurgical companies.

Ethan S. Burger, Adjunct Professor, Georgetown University Law Center, Washington, D.C.:

There is no genuine real estate market for the Russian naval base at Sevastopol. I doubt the Ukrainian Government gave much thought to organizing a tender for this choice piece of waterfront property. Imagine if China or Iran decided to make a bid.

Apart from the geopolitical implications of the arrangement between Russia and Ukraine, I wonder about the agreed upon pricing mechanism. It is hard to predict the value of the "discount" on future natural gas prices without knowing the world market price for natural gas.

It is difficult to get alarmed by what is really the status quo. So long as Ukraine remains a state with two distinct nationalities and the EU and NATO recognize that Ukraine lies in Russia's "sphere of influence," the arrangement cannot be regarded as a surprise.

Needless to say, the Georgian government cannot be ecstatic over this development. But then again, would a Russian fleet based at Novorossiisk really be looked at more favorably in Tbilisi? As for those in Brussels who are upset with the situation, maybe they should work toward improving relations with Turkey.

Russia needs to be careful not to undermine Yanukovich. If it turns out that Ukraine received a fair price for the lease extension, he cannot be accused of selling out the country's national interest. Yanukovich may favor closer relations with Russia than with the EU and NATO, but he made the most of supporting U.S. President Barack Obama's nuclear non-proliferation efforts, and he has yet to demonstrate that he is a Quisling. Perhaps a foreign policy that seeks to balance Russia off against the EU and NATO is what is best for Ukraine at present.

Professor Nicolai N. Petro, Department of Political Science, Washburn Hall, University of Rhode Island, Kingston, RI :

If Paris is worth a mass, is Kiev worth $40 billion? The answer is a resounding “yes,” and it is a very good price when one considers that Russia has already provided an estimated $47 billion to Ukraine since 2005, and received almost nothing in return.

Under the terms of the recently signed Kharkiv agreements, the Russian Black Sea Fleet’s lease is extended to 2042, with the option to extend to 2047, and the fleet will also shift to using Ukrainian producers. Russian tax payers will thus become the guarantors of the region’s economic development. In exchange Ukraine will pay 30 percent less for gas but also buy more of it, thus partially offsetting the revenue loss to the Russian budget.

But even more significantly, Ukraine now regards Russia’s Black Sea Fleet as an essential part of Europe’s security architecture, as Ukraine’s president put it, “a guarantee of security among the nations of the Caspian Basin.” The old assumption that NATO will guarantee European security has been replaced by a new paradigm that focuses on the centrality of Russia to European security.

This greatly strengthens both Ukraine and Russia in their negotiations with Europe. For Russia, revitalizing its “privileged” relationship with Ukraine makes it a crucial partner for NATO. The strategy of separating the former Soviet states from Russia, thereby forcing her to make political, economic and military concessions to the West has, for the time being, been checked. There now appear to be few alternatives to partnership with Russia on terms that actually respect Russia’s vital interests.

But this agreement also strengthens Ukraine’s diplomatic position. For years NATO and the EU have dangled the carrot of membership before Ukraine without offering anything of real substance. As the country’s economy collapsed even the emergency $16.4 billion IMF loan to Ukraine negotiated in November 2008 was suspended pending the resolution of political disagreements. Now that Ukraine has linked its economic welfare and security firmly to Russia’s, however, the West can no longer take its allegiance for granted.

The strategy of “divide and conquer” pursued by NATO in Eastern Europe has clearly failed. It should be replaced by a new strategy that aims at the simultaneous integration of the entire Slavic component of Europe into continent-wide institutions. This can only be accomplished if Ukraine becomes Europe’s indispensable partner for bringing Russia into the EU. Rather than placing the two countries on different tracks, both should be rewarded for moving together along the same path.

For starters, such partnership should remove all objections to the further economic integration proposed by the Customs Union of Russia, Belarus and Kazakhstan (which Ukraine and Kyrgyzstan would like to join), particularly since such integration is patterned on the model of the European Union and hopes to some day merge with it. It is thus a vital step toward the creation of a truly pan-European common market.

Second, such a partnership needs to think about how to move beyond NATO toward some form of pan-European security arrangement that is led by Europeans. While cooperation between NATO and the Collective Security Treaty Organization, recently proposed by Thomas Graham, would be a good idea, the fact that it has been so steadfastly opposed by NATO highlights the regrettable truth that its origins as an anti-Soviet military alliance have proved impossible to overcome.

Vladimir Belaeff, President, Global Society Institute, Inc. (USA), San Francisco, CA:

The recent agreement about the basing of the Russian Black Sea Fleet in Sevastopol is a major positive step towards peace and stability in the region. It is important to remember that Sevastopol was established specifically as a base for the Russian Navy over 200 years ago. This is centuries longer than the US Naval stations in San Diego, California or Norfolk, Virginia. Moreover, the Russian Black Sea Fleet is not a motley assortment of a few vessels, and it cannot be evicted at will from a base it has occupied for many human generations.

Therefore, a constructive solution for the basing of the Russian Black Sea Fleet post-2017 was necessary not just for Russia and Ukraine, but also for all countries that would prefer not to see dangerous confrontations about military installations in the region. That Ukraine was able to obtain a substantial benefit (although not astronomical - $3 billion per year is not an immense sum in present times) is due to the reasonableness and the emerging goodwill of both partners in the negotiations.

In fact the entire concept of a NATO-bound Ukraine was an unreal pipe-dream of a fringe element, mainly consisting of Cold Warriors nostalgic for the bad old days. NATO is now an alliance in search of a mission comparable to the old confrontation with the now dissolved Warsaw Pact. What would Ukraine contribute by its presence in such an alliance is highly questionable, from a rational point of view. Evidently Ukrainian citizens did not relish the prospect of providing cannon fodder for distant wars, or preparing their territory as the next version of the Fulda Gap. Hence, the concept of integration into NATO did not have major support among the Ukrainian electorate, and the program to propagandize joining NATO among Ukrainian voters was such a failure that it was quietly scaled down and even aborted in some localities. Remember the shoes thrown at NATO propagandists in Ukraine?

Several factors influence Ukraine’s policy change vis-?-vis Russia.

First and foremost is the inextricable interweaving of history, tradition, bloodlines, and culture between Ukraine and Russia. Moscow was founded by princes of Kiev and was ruled for centuries from that true “older brother.” In modern Russia hundreds of prominent Russians have Ukrainian surnames and family roots. One of the most beloved and influential Russian writers, Nikolai Gogol, was born near Poltava. Such links shall never be extinguished.

Secondly, Russia’s obvious success in creating a growing socially-oriented economy with an open political society that is stable and productive (consider the circus atmosphere that has prevailed of the Kiev parliament for many years now) is a very attractive incentive for Ukrainians to collaborate with Russia.

Finally, gas transit obstruction by Ukrainian political extremists is losing its value and effectiveness. The EU was not amused by the evident role of Ukraine’s anti-Russian activists in disrupting deliveries of Russian natural gas to Western Europe - not very responsible behavior for a government with aspirations to join prestigious European institutions. The inevitable development of alternative natural gas delivery routes only demonstrated the dead-end nature of petty confrontations with the neighbor to the East.

Will the new collaborative relationship take root and continue to develop? Most likely it shall. There is quite obviously much to gain for both sides. It is a genuine “win-win” situation. The alternative does not work - primarily for Ukraine, but in some aspects also for Russia. Ukrainian anti-Russians were never even a substantial minority (although they made up for their lack of numbers with aggressiveness and ruthlessness). Anti-Russian policies are so Utopian and against the grain of 1000 years of history that they simply do not work for Ukraine.

Professor Stephen Blank, Strategic Studies Institute, U.S. Army War College, Carlisle Barracks, PA:

Russia’s new deal with Ukraine on the Black Sea Fleet and gas prices has profound significance for both states and beyond for the CIS and even Europe. The deal ratifies long-term Russian gains at the expense of all the other players and continues to solidify Russia’s claim to be the possessor of a sphere of influence in the former Soviet Union. It will be recalled that Ukraine sought to obtain reduced gas prices to cope with its deep economic crisis. It had three alternatives: the first, which it pursued, was to offer Moscow a share in a consortium alongside the Ukraine and the EU to manage the reorganization of Ukraine’s gas distribution network. Moscow turned this down, because it would not have a controlling share and, equally importantly, because the opportunities for corruption in the current status quo constitute the foundation of much of Russia’s gas wealth and leverage upon Ukraine and other East European states. As the Ukrainian weekly Zerkalo Nedeli noted, if there is to be a consortium Russia wants it to be one that it controls, not one where it shares power with the EU.

Kiev’s second alternative was to bite the bullet and institute reforms within its gas economy, a well-grounded budget, and fiscal sustainability. But that course alienates President Yanukovich’s base, which depends on cheap gas and non-transparent deals. Such reforms would also generate momentum toward greater harmonization of Ukraine’s economy with those of the EU members to its West, and would thus represent a form of Westernization over the long-term. That is clearly not something Moscow wants, as the present situation affords it multiple sources of leverage. Instead, Moscow hinted that it wanted the extension of the Black Sea Fleet’s lease in return for lower prices, and Ukraine took the deal.

Consequently, Ukraine adopted this deal where it gets a 30 percent discount in gas prices (roughly adjusting the price from $330 to $230 per thousand cubic meters). It obviates the need for politically difficult reform, allows Ukraine to come up with a budget without meeting the IMF’s tough demands, satisfies Yanukovich’s base, and takes the controversial issue of the Black Sea Fleet off the table. It also rescues troubled Naftogaz from looming bankruptcy.

But in numerous ways this short-term solution represents a defeat for Ukraine and a big victory for Russia. Russia wins and Ukraine loses because the Black Sea Fleet and its accompanying socio-political, economic and cultural infrastructure enable Russia to keep the Crimea and thus Ukraine in a permanent condition of circumscribed and limited sovereignty. Moscow will retain all of its points of leverage over Ukraine and even gain more because the deal allows for Russia to build two nuclear reactors in Ukraine and preserve its nuclear monopoly (an alternative to gas) there. Apart from this limitation on Ukraine’s effective sovereignty, Russia also reinforces its tangible leverage over Ukraine by restoring its dependence on Russian subsidies and preserving Ukraine’s non-transparent gas economy.

Third, it inhibits Ukraine’s democratization and market reforms. Fourth, it thereby inhibits Ukraine’s moves toward the IMF, and ultimately the EU. Fifth, given the lease’s duration of 25 years with an option to renew for another five years, this deal all but ensures that future Ukrainian governments will be stuck with a minority controlled by Moscow in the Crimea and will find it very difficult to move westward to the EU or NATO at least until 2042.

This deal has profound implications for Ukrainian and European gas supply too. Russia is intensifying work with Ukraine on the aforementioned consortium to restructure its gas network. But with Ukraine already firmly dependent on Russia, Moscow will gain even more leverage as it builds its South Stream gas pipeline, which will essentially bypass Ukraine en route to Central and Southeastern Europe. If South Stream goes through as Moscow hopes, it will isolate Ukraine from Europe even more.

At the same time this deal shows Moscow reverting to past practices of subsidizing neighbors and “special friends” to preserve their dependence upon Russia. Russia claimed to have walked away from this policy in 2005, but never fully managed to do so. Now it is clearly going to be policy again and a powerful source of leverage on Europe and Eurasia. Indeed, Energy Minister Sergei Shmatko has announced that Russia sees no reason to revise other contracts, so the price of favorable subsidies for any other customer will be more dependence on or subservience to Russia’s objectives. Finally, this deal also allows Russia to maintain its Black Sea Fleet in place. That means it can continue to try and close the Black Sea to NATO, intimidate Georgia, and maintain constant pressure on Ukraine.

This is an extraordinarily impressive victory for Moscow, but it is a major loss for Kiev and for the EU, which continues to pay the price of having no effective energy policy toward Russia, and no effective political policy toward the members of the CIS between Belarus and Armenia. Nature abhors a vacuum, and Moscow has not only filled that space but has taken another major step toward consolidating itself as the security manager of the European CIS.
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