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Russia uses gas for rollback in Ukraine

Vladimir Radyuhin

The handling of Kiev is a clear signal that Moscow will play by its own rules in today's energy-hungry world.

A YEAR after Russia lost the battle for Ukraine to the United States, its President Vladimir Putin has mounted a new effort to woo back its biggest Slavic neighbour. Two months before a crucial parliamentary vote, Russia has hiked natural gas prices and firmly tied Ukraine to its gas supplies. It was a carefully calibrated blow designed to hurt Ukraine's pro-Western President Viktor Yushchenko in the coming election. Under a deal signed in Moscow last week, Ukraine will pay $95 per 1,000 cubic metres of gas it gets from Russia and Central Asia in 2006, up from $50 last year. Supplies to Ukraine, both from Russia and Central Asia, will be handled by a Russian-German trading company, Rosukrenergo, in which Russia's Gazprom natural gas monopoly has a 50 per cent stake. This arrangement will deny Ukraine the option of playing Russian and Central Asian suppliers against each other to secure lower prices.

The gas price hike has triggered a political crisis in Ukraine. A week after the gas deal was signed the Ukrainian Parliament voted to dismiss the Government, accusing it of betraying the country's interests. Even though the Government is likely to stay till the March election to Parliament, the no-confidence vote dealt a painful blow to President Yushchenko and boosted the chances of Opposition parties.

The March poll gives Moscow a real chance to roll back the "orange revolution" in Ukraine. A constitutional reform under way in Ukraine shifts the bulk of powers from the President to Parliament and the Prime Minister. After the parliamentary election, Mr. Yushchenko will no longer be able to push his political agenda. The new Parliament and the Government are likely to revisit the President's headlong rush towards the West.

The year that passed after the "orange revolution" has seen growing popular disappointment with the Government of Mr. Yushchenko that it brought to power. Ukraine's economy nose-dived, the Government was rocked by a string of corruption scandals and bitter infighting among "orange revolutionaries," which prompted Mr. Yushchenko to sack Prime Minister Yulia Timoshenko after barely seven months in office. According to December surveys, the party of the former Prime Minister, Viktor Yanukovich, who was backed by Russia against Mr. Yushchenko in the controversial presidential poll at the end of 2004, leads the race for Parliament. It has the support of a third of Ukrainian voters, more than 10 per cent ahead of the blocs of Mr. Yushchenko and Ms. Timoshenko.

By turning the gas heat on Ukraine at this stage, Russia hopes to further tip the balance of power in favour of pro-Moscow forces. Ukraine's economy is still bound to Russia by an umbilical cord 14 years after the Soviet Union ceased to exist. Russia is the only source of oil and gas for Ukraine's energy-intensive steel and chemical industries, which together account for 30 per cent of GDP and 45 per cent of export earnings. Out of 76 billion cubic metres (bcm) of gas Ukraine needs annually, it gets 23 bcm as payment for the transit of Russian gas to Europe, buys 37 bcm from Turkmenistan, which comes to Ukraine through the Russian pipeline system, and produces domestically about 20 bcm.

Russia has not raised the price of its gas for Ukraine since 1999. Moreover, in the past 10 years Ukraine has quietly siphoned off $2 billion worth of Russian gas transiting its territory to Europe. In the meantime, European gas prices have nearly tripled. Ukrainian households today pay less for natural gas than Russian households do. In Ukraine, almost 100 per cent of households have access to pipeline gas for cooking and heating, whereas in Russia, where the climate is far more severe, the share of households with piped gas is only just over 50 per cent.

Using cheap Russian gas, Ukrainian steel, fertilizers, cement, butter, and sugar have been successfully competing with Russian products in the Russian market. Ukraine has been making good profit exporting to Europe electricity produced at gas-burning thermal stations. Ukraine has even been re-exporting 5 bcm of Russian gas to Europe at prevailing market prices. (It has a 2006 contract to sell gas to Romania at $250 per 1,000 cubic metres.)

For all practical purposes, Russia has been heavily subsidising Ukrainian industry. This policy was geopolitically sound as long as there was hope that Ukraine, the second biggest post-Soviet economy and the largest ethnically-kin Slavic neighbour of Russia, was moving, however erratically, towards economic and political reintegration with Russia.

The "orange revolution" dashed these hopes. Kiev has firmly refused to join the Single Economic Space pact with Russia, Kazakhstan, and Belarus, and has set its sights on integration into the Atlantic structures. At the same time, it continued getting Russian gas at a mere 20 per cent of what Europe will pay in the New Year.

President Putin has now ended the absurd situation where Russia was paying for Ukraine's drift to the West. The 90 per cent hike in gas prices will not only add about $1 billion a year to Ukraine's energy bill, but will further strain its already deficit budget and will be barely manageable for Ukraine's energy-intensive economy. Russia has also reserved the right of periodic review of gas prices in line with European upward trends.

Moscow has sent a clear signal to Ukraine: if you persist in your course of breaking away from Russia and joining the West, you must pay the price. If Ukrainian voters again support the "orange revolutionaries" in the coming parliamentary poll, they should be ready to face further hikes in the gas price, which will bring the country's economy to a standstill. To underscore the option facing Kiev, Moscow has just agreed to continue selling its gas to Ukraine's neighbour and Russia's staunch ally, Belarus, at less than half the price Ukraine will pay in 2006 — $46.7 per 1,000 cubic metres.

Russia versus U.S.

The gas row has pitted Russia against the United States in Ukraine for the second time in the past 12 months. A year ago the U.S. orchestrated and actively supported the "orange revolution" coup, which stripped the Moscow-backed candidate of his victory in Ukraine's Presidential election and installed the pro-Western leader. Now Washington has firmly backed Kiev's new leadership in its gas dispute with Moscow, encouraging Ukraine to reject Russian demands of higher gas prices. President Yushchenko visibly hardened his stand on the issue after meeting Central Intelligence Agency chief Porter Goss in Kiev in mid-December.

Relying on U.S. support, Ukraine had dragged its feet over an agreement on Russian gas sales in 2006 for eight months, till Russia cut off supplies to Ukraine in the New Year. When Russia did act on its threat to leave Ukraine without gas, the State Department denounced "the use of energy [by Russia] to exert political pressure." Washington could not hide its irritation when Russia and Ukraine finally reached agreement on a new pricing mechanism. U.S. Secretary of State Condoleezza Rice sharply berated Russia for its handling of the gas dispute with Ukraine, demanding that Russia "play by the rules" as it assumed the rotating presidency of the Group of Eight.

"That kind of behaviour," Ms. Rice said, "is going to continue to draw comment about the distance between Russian behaviour in something like this and what would be expected of a responsible member of the G8."

Washington indeed has reason to feel disappointed. The peaceful outcome of the Russia-Ukraine standoff foiled U.S.-crafted plans to whip up anti-Russian feelings in Ukraine and rebuild flagging support for the "orange revolutionaries" in the run-up to the March election. Russia's radical decision to stop gas sales to Ukraine forced the latter to start siphoning off European gas from transit pipelines, raising Europe's fears of freezing in the midst of a cold winter. This helped weaken the European Union's so far unmitigated support for Ukraine. Much to Kiev's disgust Europe refused to put pressure on Russia, telling Ukraine it should learn to pay market prices for its gas supplies. The gas row has also widened a rift between the European Union and the U.S., as the latter was seen provoking an energy crisis in Europe without the risk of feeling any of its consequences.

Last, but not least, Russia has demonstrated resolve to use its energy clout to uphold national interests just as it assumed rotating presidency in the Group of Eight in 2006. With President Putin focussing on the global energy security in G8, the Ukraine gas row set the tone for the coming G8 summit in St. Petersburg, showing the west that Russia will play by its own rules in today's energy-hungry world.

This lesson is likely to have a direct impact on the March election in Ukraine. It may help dispel the "orange revolution" euphoria that the west will stand by Ukraine in any confrontation with Moscow and that the weakening of ties with Russia will necessarily benefit Ukraine.

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