Gas Issue Points to Ukraine's Failures

A worker in Kiev views an indicator board at the main gas distribution center of Naftogaz, the state energy company. (By Efrem Lukatsky -- Associated Press)

"They simply didn't know what to do, and therefore made many mistakes," said Viktor Yanukovich, the pro-Kremlin politician who was defeated in the Orange Revolution and who now leads the largest party in parliament.

Russia has sold natural gas to Ukraine at below-market prices since the fall of the Soviet Union, a legacy of the communist planned economy. But many scholars say cheap gas has hurt Ukraine more than it has helped, creating opportunities for corruption because billions can be made by those with access to the fuel.

The Orange Revolution raised hopes for reform, with the government launching an investigation into the gas sector.

But in September 2005, Yushchenko dismissed Tymoshenko as prime minister, and in January 2006, after a brief standoff, Ukraine and Russia struck a new gas deal. Yushchenko hailed the contract as a victory because it allowed Ukraine to continue receiving gas at subsidized prices for another year. In exchange, Ukraine agreed to charge Russia a low fee to use its pipelines.

It soon became public, however, that the contract allowed Russia to increase gas prices every year but fixed Ukraine's transit fee for five years, a condition that severely weakened its negotiating position this month.

In addition, the deal gave a shadowy intermediary company, RosUkrEnergo, full control of gas imports from Russia, as well as access to the Ukrainian domestic market. Gazprom, the Russian gas monopoly, owns half the firm, and two Ukrainian tycoons say they own the other half. Tymoshenko says the company is a vehicle for corruption benefiting both Russian and Ukrainian officials.

"It was a huge opportunity lost," said Edward Chow, a senior fellow at the Center for Strategic and International Studies in Washington, who argues that Ukraine's failure to reform its gas sector continues to "destroy public trust in its politics, and undermine the interests of its European neighbors."

The gas deal came under attack in the newly assertive Ukrainian press. Yushchenko stood by it while his allies accused its most prominent critic, Tymoshenko, of being upset because her own attempts to profit on the deal had been thwarted. No investigation ever sorted through the competing accusations.

Igor Burakovsky, director of the Institute for Economic Research and Policy Consulting in Kiev, said the situation is typical of Ukraine's incomplete democratic transition. There is free speech and wide access to information, he said, but fervent debate rarely leads to action because of the weakness of the courts and other institutions.

"It creates a cloud of cynicism," he said. "People believe everyone is a thief, but nobody is ever punished."

U.S. officials have urged Ukrainian leaders to reform the gas sector by boosting domestic production, improving energy efficiency and eliminating RosUkrEnergo. But analysts say corruption has worsened because political uncertainty has encouraged short-term thinking. Yushchenko has appointed four prime ministers in as many years.

In 2007, the state energy firm, Naftogaz, tried to determine what it should be charging Russia to use its pipelines. Yuri Vitrenko, the economist who supervised the analysis, concluded Ukraine was getting paid much less than it cost to operate the pipelines and recommended a sharp increase. But the government responded by asking him to justify the lower fee. "They just wanted to keep the old deal," he said.