Russia gains leverage in Ukraine as gas debts pile up due to credit crunch

By bne IntelliNews October 8, 2007

Roman Olearchyk in Kyiv -

The endless tussle between Kyiv and Moscow for control over the gas that flows from Russia through Ukraine on its way to Europe appears to be going the Kremlin's way due to the $1bn in debt to Gazprom that Ukrainian firms have piled up, which in part has been caused by the credit crunch.

Settling this debt to Gazprom depends largely on access to short-term financing for these politically vulnerable trading companies, which have yet to pay Gazprom for large volumes of gas pumped into Ukraine's vast underground storage facilities ahead of peak winter demand in Europe. However, with the credit crunch preventing access to this financing, the other option would be for Gazprom to swap this debt for a share of the gas in storage, giving the Russian company control of the gas at the border and enabling it to pump supplies to Europe while reducing shipments to Ukraine in any price dispute.

Vitaliy Kisil, a spokesman for the Ukrainian-Russian joint venture Ukrgaz-energo, said his company's debt has swelled this year to $1bn due to difficulties in landing financing on the world's credit markets. Poor payments for gas resold to households and state utilities by Naftogaz, Ukraine's debt-ridden state energy company, has increased the burden. "We are anticipating better conditions on the international debt market in the very near future and hope to raise such financing allowing us to pay these debts," says Kisil.

Time is running out. Gazprom warned last week that gas shipments would be reduced if Ukraine fails to settle a $1.3bn bill for gas already supplied. This announcement triggered fears both countries are headed for another energy standoff, with the worst-case scenario being a repeat of a 2006 price dispute that caused a reduction of gas supplies to Europe.

Suspicious timing

The timing of Gazprom's announcement, made just days after Ukraine's snap parliamentary elections, also raised suspicions it was politically motivated. Opposition leader Yulia Tymoshenko has a good chance of returning as prime minister, a post she held briefly in 2005, and has pledged to remove intermediary companies from the gas trade between Ukraine, Russia and Central Asia.

Since the announcement by Gazprom, Ukrainian officials have been at pains to stress that the debts are not owed by the state, as Gazprom originally alleged, but by the Russian energy giant's gas trading partners with Kyiv. Both Swiss-registered RosUkrEnergo and Ukraine-based Ukrgaz-energo gained control of the Russian gas sent to Ukraine via the controversial agreement that ended the 2006 price dispute.

About $1bn of this debt is directly owed to Gazprom by RosUkrEnergo, the monopoly suppler of Russian and Central Asian gas to Ukraine. RosUkrEnergo is owned 50-50 by Gazprom and two Ukrainian businessmen, Dmytro Firtash and Ivan Fursin. RosUkrEnergo's main debtor is Ukrgaz-energo, the major Ukrainian gas supplier to domestic industry, the best payers. Ukrgaz-energo is, in turn, 50-50 owned by RosUkrEnergo and Naftogaz. Naftogaz has suffered financially since 2006 when it was forced to give up supplying gas to industry to Ukrgaz-energo, and is now stuck with supplying gas to cash-strapped households.

In early October, Ukraine Energy Minister Yury Boyko pledged that Gazprom's debt would be settled by November 1, but provided little detail on how and what the government's role would be. Speaking on television on October 5, Boyko said the debt owed by these trading intermediaries was for gas purchased ahead of the winter period and stored in Ukraine's vast underground storage facilities. "These companies have this gas, but they haven't paid Gazprom for it as of today," he said.

Spokesman Kisil said Ukrgaz-energo is "confident" of soon signing a short-term financing agreement to pay RosUkrEnero, which would, in turn, pay Gazprom.

A Kyiv banker said the while the credit crunch doesn't pose a major risk to reputable Ukrainian companies overall, the business of providing short-term loans for politically sensitive gas dealings could be considered risky.

Gas swap and its implications

A Ukrainian government source said Gazprom could swap the debt for a share of the 30bn cubic meters (cm) of gas currently stored in underground facilities in Ukraine. Nearly 20bn cm of this gas is owned by RosUkrEnergo and Ukrgaz-energo.

Gazprom officials have declined to confirm or deny such a possible settlement, though gaining control over this gas would beef up Gazprom's leverage in price negotiations for next year with Ukraine, whose pipelines serve as the main artery for supplies from Russia and Central Asia to the European Union. Control over this gas would enable Gazprom to squeeze Ukraine by reducing supplies while keeping shipments to Europe stable.

"Without a doubt, such a scenario would not leave Ukraine with a good negotiating position in gas price talks," says Oleksiy Ivchenko, former head of Naftogaz and a close associate of Ukraine's pro-Western president, Viktor Yushchenko.

Ivchenko accuses Ukraine's current energy minister, an appointee of former pro-Russian Prime Minister Viktor Yanukovych, of deliberately playing along with Gazprom to build up debts in order to help Moscow gain leverage in gas price talks and take over the country's prized gas pipeline system. "RosUkrEnergo and Ukrgaz-energo are Gazprom's partners. It was Gazprom's will to set up such a structure, giving them such a big role," he alleges. "These debts are dubious... they were purposefully created to make Ukraine a debtor to RosUkrEnergo. In return there will be an attempt to lay claim to Ukraine's vast gas pipelines as payment for debts."

Ivchenko headed Naftogaz during the 2006 price standoff when Kyiv and Moscow agreed a stiff price hike and the increased role of RosUkrEnergo and Ukrgaz-energo in the supply of gas. Ukraine held the advantage back then, Ivchenko insists, stressing that the compromise agreement reached prevented Gazprom from gaining control over underground storage and raising gas prices unilaterally. "When I was in charge of Naftogaz, all the gas that was in underground storage was owned by Naftogaz and we regulated it. We supported Europe when Gazprom started shutting off gas supplies back then in 2006. Today, the gas in underground storage is not the ownership of Ukraine, but of these companies. These companies, if they want to put pressure on Europe or Ukraine, are free to do so and fully in control of the gas supplies to Europe," Ivchenko says.

Talks between Kyiv and Moscow over the price of gas sent through Ukraine are expected to start after a new Ukrainian government is formed. Energy Minister Boyko expects a price hike of no more than 10%, but the country's economy is still adjusting to two stiff price hikes in the last two years that more than doubled the price Kyiv pays to a rate of $130 per 1,000 cm.

James Sherr, from the UK's Defence Academy, describes the energy relationship between Ukraine and Russia as "a museum of contradictory truths."

"On the one hand, Gazprom is squeezing Ukraine and other post-Soviet states to get out of a trap of its own making: underinvestment in new production. [This] is the only way to meet rising demand in the EU and in Russia itself," he says. "Whoever runs Ukraine, however pro-Russian the government, the squeeze will continue, and the spasms between stability and crisis will grow shorter and sharper.

However, if Tymoshenko becomes premier, Sherr says the gloves will come off. "The challenge for key players, starting with Mr Putin, will be to lure [Tymoshenko] into striking first. The moment she goes after RosUkrEnergo or UkrGazEnergo, they will have their pretext. If she's wise, she will she will stay out of those perilous waters until the country is stronger. Instead, she needs to create a level playing field that will bring Western energy companies into new investment projects," he says.

"She needs the respect and support of the EU, and she won't get it as long as they see her as a populist and ideologue," he says. "If she can't become a courageous, tough-minded pragmatist, she won't be able to rise to the occasion. Even with a solid majority in parliament, that would be tough. In the current morass, it's going to be much tougher," Sherr added.

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