A Way Out of the Dead End

13 October 2011, 14:57

Kennedy was the first Western politician to note the Chinese spell crisis with two hieroglyphs – one meaning danger, and the other, opportunity. Quite a few speechmakers have made use of the symbol since then, including former Ukrainian President Leonid Kuchma. The wisdom in the Chinese writing has often encouraged people to look for ways out of dead ends. Ukraine faced this challenge after signing the 2009 gas contracts with Russia.


Much has been said about the dark side of the deals. Obviously, the price raises the most complaints from the current government and its sponsors and surfaces most frequently in the media. Yet, discussion is not about the figure alone, but about the price formula, as well. The price of gas was essentially equal to the average European rate when the deals were signed but grew higher than any European prices in 2011. This is a result of the coefficients used in the formula and the selection of basic fuels. For some reason, gasoil produced after primary refining is one of these components. It is often used in the EU and is more expensive than the heavy oil which is more common in the Ukrainian market.

Moreover, the deals set a low price for the transit of Russian gas to Europe and restricted its being increased. Consequently, gas transit through Ukraine remains cheaper than elsewhere in Europe.

In addition, the contract employs the take-or-pay approach. This means Ukraine must pay for over 30bn cu m of gas a year regardless of how much the country really needs. This is one of the factors hampering the decline of Russian gas consumption: recently Gazprom managers stressed that Ukraine must pay for all its gas whether or not it orders the fuel.

In addition, the deal entails discriminating approaches to imposing sanctions. If the Ukrainian party is not happy with anything it can start negotiations with the Russians and go to court after a month of ineffective talks. Yet, if Ukraine delays contract payments, including settlements for the gas it does not need, the sanctions to be imposed are already in the contract. Russia is entitled to demanding advance payment for the gas and imposing a fine worth a few times the amount of payment.


Today, it is hard to recall what pushed the parties to sign the deal. People presume that then-Prime Minister Yuliya Tymoshenko had political reasoning behind the move and/or expected she would be able to change the terms along the way. In mid 2009 she convinced Vladimir Putin to exempt Ukraine from sanctions for not buying the gas Ukraine’s economy did not need. Apparently, the Russian party had its own reasons. In addition to being beneficial for Russia, the deal allowed the Kremlin to use some passages in the biographies of Ms. Tymoshenko and other politicians that would force them to meet their contract liabilities. The role of Andriy Portnov, a close ally of Ms. Tymoshenko then and advisor to President Viktor Yanukovych now, in the deals still leaves people guessing. Many people say he was involved in the unexpected decision to arrest the ex-PM. Many sources also link him to Viktor Medvedchuk a former king-maker close to the top Russian establishment.

In the end, Russian Prime Minister Vladimir Putin is the only person who can answer all these questions. But, for obvious reasons, all requests to him to testify in the gas case were never answered.

So now the results of the 2009 deals are a matter of discussion regardless of the reasons behind them. They could affect the Yanukovych government the same as the political reform of 2004 affected Mr. Yushchenko and Ms. Tymoshenko — being the Trojan horse brought by the previous government that ruined the plans and expectations of the new authorities. The political reform provided an institutional basis for the individual conflict and the struggle for power between the Orange leaders while gas deals threaten the formula of pouring wealth into Ukrainian oligarchs' pockets via windfall profits and cheap resources.


Given the special nature of Ukrainian politics, the alternatives are easy to picture. Virtually every relatively inexpensive gas contract had a non-transparent — read corrupt — component to it catching the interests of officials in both countries. Moreover, every new deal turned out to be more beneficial for the Russians and the appetites of intermediaries involved kept growing. If the gas supply terms continued to be coordinated and agreed annually, the government would likely be tempted much more to trade national interests. This would mean they could negotiate cheap prices for their businesses and in that war all is fair. Last year, those in power agreed to prolong the stay of the Russian Black Sea Fleet fleet in Ukraine for 25 years, an embarrassingly lengthy term, only to get a discount of USD 100 that, in fact, hardly changes the situation.

Russian is offering Ukraine a menu that includes the Customs Union, the integration of oil and gas companies and other initiatives to hand over Ukraine’s economic sovereignty to supranational bodies where the Russian Federation is the decision maker. These approaches would hardly be any different if there was no long-term contract. Instead, Russia would threaten steep hikes in the price of gas and engender unknown degrees of risk, similar to what it did in 2005 and partially in 2008, as leverage to get what it wants. Today, the worst scenario is in fact already in place: the price has gone up so the key bargaining chip has been used.

Clearly, the government could try and negotiate a lower price but it needs arguments for that which it has yet to find. If it risks taking a move of principle, the gas price could end up at international arbitrage. But this sort of case can take years to resolve. Until then, the Ukrainian government and business owners close to it will be forced to live with the available gas supply terms.


In other words, the government now has what all its predecessors did their best to delay: Russia is no longer selling fuel to Ukraine at discount prices. The West suffered a similar shock in the 1970s as did many former Soviet republics in the 1990s. This was inevitable for Ukraine and it finally happened. The current government might think it is unfair that it is being forced to deal with the consequences, but the well-known truth is that there are no friends in international relations, only interests.

If the attempts to change the terms of the contracts have no guaranteed chance for success, in international arbitrage for instance, or take too much in return, such as consents to the Kremlin’s integration ambitions leading to the loss of sovereignty, the only chance is to find benefits in the available terms.

Despite all the above mentioned flaws, the 2009 contracts do have several critical benefits. First, they offer long-term conditions. The rules of the game are known and convenient for Russia until 2019, thus no attempts to suddenly revise them are expected any time soon. Second, the price for gas is predictable making it easier to plan ahead even if Ukraine needs to get used to buying expensive gas. These are fundamental conditions for officials who can plan ahead and sincerely want to improve the state of affairs in the country. They encourage flexibility and understanding the situation a few years ahead.

This is the only environment that inspires real economic interest as those in power seek alternative gas sources, the development of domestic extraction of conventional gas, shale gas, coalbed methane and so on, and alternative energy sources, let alone effective energy saving and efficiency measures.

This streamlining and projects to develop alternative energy sources or gas suppliers require investment. The estimated dozens of millions of dollars funnelled abroad earlier could be quite enough to do all that. The owners of Ukrainian enterprises expected to upgrade their facilities in 2015-2020 when they run out of reserves remaining from Soviet times. Yet they may have to review this deadline.


This is Articte sidebar