Russia offers huge gas discount, claims Ukraine

By bne IntelliNews October 10, 2012

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The Kremlin is deadly serious about getting Ukraine to join its answer to the European Union. Just how serious became apparent on October 9, as Ukraine's Prime Minister Mykola Azarov announced Russia has offered to drop gas prices for struggling Kyiv to just $160 per 1,000 cubic meters should it join the Customs Union.

The offered price is even less than that for Belarus - Moscow's best friend in the CIS currently - and a fraction of the prices paid by European customers. The $400 plus that Ukraine is now paying is one of the biggest elements pulling the economy into the mire. "Russia is putting forth conditions to us," Azarov said during a trip to Odesa. "Join the Customs Union, and tomorrow you will get gas for $160."

The offer is doubly attractive since the second phase of the Nord Stream gas pipeline that by passes Ukraine came online this month. As much as 80% of the gas Russia sends to Europe has been routed through Ukraine, earning the country significant transit fees, but that business will wind down now that Russia is developing alternatives. The Kremlin said this week it is already drawing up plans to expand the capacity on the route even further.

However, Kyiv remains reluctant to join the Customs Union, which came into existence at the start of 2010, as it would block its professed ambition to join the EU. However, that option has been receding thanks to the bumbling of President Viktor Yanukovych, and Brussels has refused to sign off on a partnership agreement and a free trade agreement.

That leaves Ukraine in limbo between the two. For the Kremlin, getting Ukraine into the Customs Union - which already contains Belarus and Kazakhstan - is key; the project makes a lot less sense without one of Russia's largest trading partners. Azarov admits that inclusion in the Customs Union may be in Ukraine's interest, as about 40% of international trade is with its members. However, he pointed out that another 30% is with the EU, so a free trade agreement and political association with the EU is equally attractive.

According to Ukraine's national oil and gas company Naftogaz Ukrainy, Russian gas cost the country about $416 per 1,000 cubic meters in the first quarter, $425 in the second, and around $426 in the third. Those prices have piled the pressure on the economy, with the government refusing IMF demands to hike domestic tariffs ahead of forthcoming elections. That has seen the country's 2010 $15bn bailout programme frozen due to the massive hole in the budget created by state subsidies to consumers.

Over the last 18 months or more, Kyiv has been badgering Moscow to renegotiate the pricing formula in the long-term gas contract signed by Yulia Tymoshenko in 2009. The former Prime Minister was jailed for the agreement earlier this year, charged with abuse of office, but Russia has refused to compromise as it looks to leverage the situation.

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