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Gas Issue Points to Ukraine's Failures
Nation Weakened By Dispute With Russia, Many Say

By Philip P. Pan
Washington Post Foreign Service
Monday, January 19, 2009

KIEV, Ukraine -- In the heady months following the Orange Revolution, after the crowds had swept the democratic opposition into power but before the hopes inspired by the movement had begun to fade, Ukraine's new, American-backed leaders decided to renegotiate the terms on which the country purchased natural gas from Russia.

President Viktor Yushchenko, the former banker who defeated the Kremlin's favored candidate, had campaigned on a promise to fight corruption, using the rallying cry, "Put the bandits in jail!" The gas contract with Russia, a notorious source of patronage and cash for the old regime, was a natural target for his new government.

But now, as Ukraine prepares to sign an accord ending an 18-day Russian gas embargo that disrupted energy supplies in much of Europe, the consensus here is that instead of cleaning up the gas trade, Yushchenko's first gas deal left this former Soviet republic more vulnerable to bullying by Russian leaders determined to thwart its turn to the West.

Concessions made three years ago -- under suspicious circumstances, some say -- sharply reduced Ukraine's leverage against Russia in this month's crisis. More broadly, according to a wide spectrum of political figures, journalists, diplomats and analysts, the Orange Revolution's failure to eliminate the corrupting influence of cheap Russian gas poisoned Ukraine's transition to democratic politics, tarnishing its reputation abroad and leaving much of the public here disillusioned.

"There are no reformers left," said Alexander Dubinsky, a business journalist for the Ekonomicheskie Izvestia newspaper. "After a reformer gains power, he becomes corrupt, too. That's what people think now."

In explaining the importance of access to Russian gas in Ukrainian politics, he added: "All the big money here was made in gas. If you control the gas, you can control industries, you can control politicians."

Early Sunday, Russian Prime Minister Vladimir Putin and his Ukrainian counterpart, Yulia Tymoshenko, emerged from late-night talks in Moscow with the outline of a deal to end the midwinter standoff over gas prices that has left large parts of Europe struggling to maintain heat and electricity for 12 days.

Russia said it would grant a 20 percent discount to Ukraine on European gas prices this year, while Ukraine agreed not to raise the low fee it charges Russia to use its pipelines to deliver gas to Europe. Tymoshenko was scheduled to return to Moscow on Monday to sign the contract, but the details, which have derailed previous deals, were still being worked out.

Depending on the fine print, the agreement will probably mean a gas price not far from the final negotiating positions of both sides before talks broke down, suggesting that the standoff has always been less about commercial differences than political ones.

Many in Ukraine and the West have seen it as an attempt by Russia to assert its influence in the region and weaken the pro-Western government of a neighbor, a sort of non-violent sequel to its August war against Georgia.

But the crisis also highlighted much of what has gone wrong with Ukraine's experiment in democracy, including a crippling feud between the Orange Revolution's leaders, Yushchenko and Tymoshenko, and a weak judiciary that has been unable to address pervasive allegations of corruption.

The political disarray has played into the Kremlin's efforts to portray Ukraine to the world as a failed state, unfit for membership in NATO and the European Union, and to convince the Russian people of the superiority of Putin's more authoritarian model of government.

"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.

Yushchenko's failure to bring corruption under control has contributed to a precipitous drop in his approval ratings, from highs near 75 percent after the Orange Revolution to less than 5 percent now.

Bohdan Sokolovsky, Yushchenko's representative on energy security, said the president was not directly involved in the 2006 gas deal and argued it may have been the best contract possible at the time. But he acknowledged that the government needed to do more to reform the gas sector.

"We remain critical ourselves about the too-slow pace," he said, especially "because there were higher expectations" after the Orange Revolution. He added that the government was continuing to work on the problem "step by step."

"The less politics in the energy sector, the more just and open it will be," he said. "This is the position of President Yushchenko."

Tymoshenko, who was appointed prime minister again in late 2007 and is expected to challenge Yushchenko for the presidency this year, told reporters last week that Ukrainian politicians derailed a December deal because she had insisted on cutting out RosUkrEnergo. She did not accuse Yushchenko directly, but only the president would have the power to overrule her.

An official in the president's office fired back Friday, accusing Tymoshenko of being "hooked by Russian special services" and recalling that she made a fortune in the 1990s as chief of a gas trading firm that was investigated for criminal activity.

"We think it was a crime," Hryhoriy Nemyria, one of her deputy prime ministers, said of the 2006 gas contract. "It basically created a situation of strategic vulnerability for Ukraine."

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