Gazprom and Ukraine in lucrative and difficult tango


Supporters of former Ukranian Prime Minister Yulia Tymoshenko hold her picture as they protest in front of the court in Kiev on Aug. 29. The gas business made a fortune for Tymoshenko in the 1990s, thrust her into politics a decade later, and, now that she’s a former prime minister, has put her into prison. (AFP/Getty Images)
October 19, 2012

Gazprom’s foreign customers are asserting themselves more boldly in their dealings with the giant Russian energy company. French, German, Slovakian and Turkish companies have renegotiated their contracts for natural gas; the European Union has launched an antitrust investigation; and Lithuania recently filed a $1.9 billion legal claim against Gazprom over alleged price gouging.

But no country is more bound up in Gazprom’s increasingly troubled fortunes than Ukraine. And no country has had as little success in dealing with Gazprom. Ukraine has simply been too important to Russian energy policy — and to the flow of money that policy supports.

Exports of natural gas to Europe account for 75 percent of the Russian energy company’s profits, and most of that gas goes through Ukraine. Ukraine is the company’s second-largest customer, after Germany. And for a decade, Gazprom and its revenue have been the most important financial support for the system constructed by President Vladimir Putin.

Now that support is in trouble, in the face of a dramatic decline in gas prices worldwide. But it’s not clear whether that will bring relief to Ukraine. Russia, in fact, is using Ukraine’s energy woes in an effort to bring the country firmly into Moscow’s orbit.

Almost from the start of independence 21 years ago, the relationship has been a rocky one. Twice, Gazprom has cut off the supply to Ukraine. Gazprom is widely viewed as a major enabler of corruption here, using proxies to spread money throughout the political class, though plenty of Ukrainians say the blame lies primarily on their side of the border. And Gazprom has been the most important tool in Putin’s often aggressive policies toward Russia’s big neighbor.


Natural gas in Ukraine (The Washington Post/Source: Energydelta.org)

Ukraine, heavily dependent on natural gas as a fuel source, has “failed miserably” in fashioning an intelligent energy policy, according to a new report by a panel at the U.S.-Ukraine Foundation headed by Edward Chow, a former Chevron executive now at the Center for Strategic and International Studies. “The root cause is nontransparent business practices leading to pervasive and massive corruption in the energy sector.”

The gas business made a fortune for Yulia Tymoshenko in the 1990s, thrust her into politics a decade later, and, now that she’s a former prime minister, has put her into prison. Its tentacles have reached deep into Ukraine’s political structures. The business involves so much money, all of it with a Russian stamp, that Ukrainian sovereignty could be called into question.

Ukraine has been a major playing field for middlemen who help manipulate large sums of cash — income that shows up in European bank accounts and in bankrolls that find their way back to Moscow.

Until 2009, Gazprom sold cheap gas to a Ukrainian dealer, a Swiss-registered company called RosUkrEnergo (RUE), which turned around and, as a monopoly, sold it at an immense profit. RUE is half-owned by Gazprom; most of the rest is owned by a Ukrainian oligarch, Dmytro Firtash.

The use of a middleman enabled Gazprom to park its proceeds in foreign bank accounts, and out of the public eye.

Oleksandr Turchinov, Ukraine’s former head of intelligence, called it a criminal scheme. Now a leading member of the opposition, he said during an interview that he was fired as soon as he began investigating it. The arrangement provided Gazprom’s managers, under Putin’s direction, with a gigantic slush fund.

RUE, Turchinov said, “wasn’t accountable to any government. They could freely manipulate vast resources — including cash.”

Squeezed out

In 2009, Tymoshenko, then the prime minister, squeezed RUE out — but at a cost. Ukraine agreed to pay Gazprom handsomely for the chance to receive its gas directly at a markup of about 60 percent over what analysts consider a realistic price. Since then, Ukraine has fallen ever more deeply into debt over its gas bills, which come to about $12 billion a year, and Ukrainian officials warn that Putin will use that debt to coerce Ukraine into joining a Moscow-based customs union that includes Belarus and Kazakhstan.

Speaking in Odessa last week, Ukrainian Prime Minister Mykola Azarov said Russia has offered, coincidentally or not, a 60 percent reduction in price if Ukraine comes on board. Ukraine, he said carefully, must consider the effect on its trade with the rest of Europe before taking such a step.

Joining the customs union, said Volodymyr Omelchenko, an energy expert at the Razumkov Center think tank here, would spell the end of Ukraine’s European ambitions and put it directly under the thumb of the Kremlin.

Tymoshenko is in prison for “misuse” of her office in promoting that deal. Through RUE and another company, OstChem Holding, which is registered in Cyprus and based in Vienna, Firtash has regained a role on the more profitable margins of the gas business, and the man who reportedly helped devise the RUE scheme, Yuri Boyko, has become Ukraine’s minister of energy.

Boyko is in charge of negotiating a better price for Ukraine, but the talks have been slow. In return, Russia would like to gain control of Ukrainian pipelines as well as draw Kiev into the customs union. Ukrainian politicians rail against the deal Tymoshenko struck, but they haven’t done much about it. Many, Omelchenko said, have business interests that depend on Gazprom, and that’s not a coincidence. Russian intelligence agencies, working on behalf of Gazprom, have compiled dossiers on chief Ukrainian leaders in the event that blackmail is required, he said.

South Stream pipeline

At the same time, Gazprom is pursuing a $20 billion plan to build a pipeline, called South Stream, that would enable it to export gas to Europe while bypassing Ukraine entirely, thus depriving Kiev of transit fees. (Gazprom would not bear the entire cost of the project.)

South Stream would make it possible for Gazprom to shut off the supply to Ukraine without disturbing its European customers downstream. The pipeline would be a powerful political weapon against Kiev — though commercially, analysts agree, it makes no sense. There is no market for it, and not enough gas to fill it.

It would, however, make Kremlin-connected contractors happy.

“There is a very big corruption tax,” said Mikhail Krutikhin, an energy analyst with the Moscow firm Rusenergy, in a reference to the project’s high cost.

In the face of this huge expenditure, Gazprom’s export business is sputtering. That gives most European customers more bargaining power. But it could cause Gazprom to put even more pressure on Ukraine — which may be the last captive market — than ever before.

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