The smell of gas in the courtroom

By bne IntelliNews October 24, 2011

Graham Stack in Kyiv -

The verdict handed down by a Kyiv court against Ukraine's former prime minister Yulia Tymoshenko on October 12 put the braided lady back on the world political map, receiving a seven-year jail sentence for what seemed a bureaucratic technicality of exceeding her powers when negotiating a deal over natural gas imports with Russia in January 2009. But the target of the trial may not have been so much Tymoshenko, as the gas treaty itself.

While trials like that of Tymoshenko, and the now legendary Russian prosecution of oligarch Mikhail Khodorkovsky, owner of oil giant Yukos, might get billed as show trials pitting good against evil, there are mostly very concrete questions of control and pricing of energy resources at stake.

When elite conflicts erupt in such a spectacular fashion, it is usually because key players have miscalculated. And in both cases, Khodorkovsky and Tymoshenko may have miscalculated the same thing - the price of oil.

The spiralling price of oil in 2003 had turned Khodorkovsky's Yukos into an asset so valuable and strategic that the Kremlin could not contemplate its sale abroad unrecompensed. Conversely, in January 2009, when Tymoshenko ordered state-owned energy company Naftogaz Ukrainy to sign a deal with Russia's Gazprom, she had her eye on the plummeting price of oil. After hitting an all-time high of $147 per barrel in June 2008, the price had dropped like a brick as the financial crisis swept over the world in the fall. By the end of September, it had dropped by more than 50% to below the $70 mark. And on December 23, the oil price touched $30. Consensus forecasts were for $50-60 in 2009 and 2010, with a drop to $25 regarded as possible if the financial crisis spread to China.

As it happened, things turned out differently.

A blinking oil light

Until early March 2009, the oil price fluctuated between $35-45 per barrel, then it started to crawl back up - and it's still crawling around the $100 mark. But for Yulia Tymoshenko in January 2009, memories of 1998 when the oil price collapsed into single figures may have been uppermost - with crucial implications for her strategy.

Because there is no real gas market like there is for oil, prices for long-term gas contracts are indexed to those of the substitute fuel - heating oil - so the price of gas for any given quarter is an average mainly of the heating oil price over the previous nine months. With an eye on the falling oil price and a politician's gift for wishful thinking, she could regard the gas war as won without a shot being fired. If the oil price in 2009 stayed at $30-40, Ukraine could sign up to the full European-level index price of $450 per thousand cubic meters (/'000 cm) - and still get a gas price of $129-173/'000 cm going forward, ie. less than half of what was originally on the cards. Even the consensus forecast oil price for 2009 of $50 would give a gas price of $210/'000 cm, according to the agreed formula, substantially less than the $250/'000 cm originally demanded by the Russians in 2008.

And for making such a "concession" to the Russians to pay the European-level index price, she could demand something in return: the destruction of the opaque gas transport business of Dmytro Firtash, owner of RosUkrEnergo - a company selling Central Asian gas to Ukraine via Russia. RosUkrEnergo was a key financial backer of the then opposition Party of Regions and its leader, now President Viktor Yanokovych, as well as purportedly an influence over the presidential secretariat of former president Viktor Yushchenko, Tymoshenko's other arch rival. Eliminating the gas trader would also go down well in the West.

Gazprom threw a sweetener into the bargain: in return for Kyiv signing up for full European prices, without even a discount to reflect the cheaper cost of shipping gas to Ukraine than to Germany, Gazprom agreed to include a 20% price rebate for 2009. This got Tymoshenko a gas price for the first quarter of 2009 - ie. still linked to the oil price peak of 2008 - of around $230, lower than the price originally demanded by Russia - and sufficient for her to claim "victory" with the price to drop sharply later in the year.

But by June 2009, as massive stimulus packages in the West and China started to kick in, and Opec production quotas proved more effective than thought, world oil prices were back up at $70, implying around $300/'000 cm gas according to the new formula - and prices haven't looked back since.

It's the gas, stupid

Tymoshenko's miscalculation explains the strange constellation of forces that formed around her trial. Former arch-enemies like current President Yanukovych and former president Yuschchenko lined up together against Tymoshenko, Moscow and the West.

Russian Prime Minister Vladimir Putin himself sounded surprised at the position he found himself in supporting Tymoshenko against Yanukovych. "She's in fact a political opponent, as a pro-Western politician," he commented to journalists while on a state visit to China, while going on to explain why he found the verdict strange: "Tymoshenko herself did not sign anything." The Russian foreign ministry in a statement noted, "an obvious anti-Russian subtext to the entire saga."

Meanwhile Tymoshenko's former bosom ally during the Orange Revolution, ex-president Yushchenko, a passionate US-linked pro-westerner, forcefully testified against Tymoshenko during the trial, and defended the judge's verdict. "I don't see a show trial, but rather a normal judicial process. Even politicians are not above the law. Wasn't former French president Jacques Chirac also forced to stand trial?" Yushchenko told Germany's Der Spiegel in a recent interview.

Representatives of the now ruling Party of Regions have gleefully pointed out that the criminal inquiry into the gas contracts with Russia was in fact initiated by Yushchenko's pro-Western administration in February 2009.

Yushchenko hates the gas deal for weakening Ukraine's position with regard to Russia - leading directly to the 2010 Kharkiv agreements that extended the lease of Russia's Sevastapol Black Sea naval base in return for a further 20% gas price rebate. Yushchenko has frequently said he suspects Tymoshenko of having sold out to Russia as early as August 2008, when she kept uncharacteristically silent over Russia's incursion into the Georgian rebel region South Ossetia.

Party of Regions supporters, for their part, hate the 2009 agreement because of the impact it's had on industry. And while the number of Yanukovych backers includes many of the country's energy-hungry industrialists, there is one man in Ukraine who may be hurting more than the others at the current spiralling price of gas: gas trader and chemicals tycoon Dymtro Firtash, co-owner of Rosukrenergo.

Chemical brothers

After Tymoshenko's 2009 gas agreement pushed him out of the lucrative gas transit trade, Firtash bought up the lion's share of Ukraine's chemicals sector, shelling out around $2.3bn in 2010 and 2011 to now dominate the industry that accounts for around 10% of the country's exports.

With gas making up 70-80% of production costs of chemicals, experts regard these plants as profitable with a gas price of around $250/'000 cm. Firtash' representatives had given to understand that he had negotiated such from Central Asian suppliers.

But according to energy sector analyst Stanislav Zelenestsky of Art Capital brokerage, recent import statistics show that any cheaper price that Firtash may have negotiated nevertheless appears to be indexed to Ukraine's import price as agreed with Russia. Ukrstat and Ministry of Economy figures show that Ukraine imported Central Asian gas at an average price of $359/'000 cm in September, up from a second-quarter price of $280. According to Zelenetsky, this means that Firtash's largest chemical plant Stirol alone could post a net loss of $17m-18m for the third quarter, and $60m over the whole year.

Opposition members including Tymoshenko have alleged that Firtash is directly linked via business interests to top members of the Yanukovych administration, including Chief of Staff Serhiy Lyovochkin, Energy Minister Yuriy Boyko and Security Service of Ukraine head Valeriy Khoroshkovsky, in turn linked to the country's largest TV channel Inter, although these officials have denied this.

One part of the 2009 deal that saw gas worth about $3bn apparently owned by Firtash's Rosukrenergo and stored in Ukraine transferred to the state-owned Naftogaz, has already been reversed by a decision of the Stockholm International Commercial Court. Der Spiegel later looked into the court decision and found that, after Yanukovych won the presidency in 2010, Naftogaz had simply backed down from its claim to the gas, effectively conceding the case to Rosukrenergo. Now there seems little doubt that Ukraine will proceed to use the Tymoshenko court decision to pressure Russia to renegotiate the rest of the 2009 gas agreements.

Meanwhile Ukraine's prosecutor general is making it clear that it is not yet finished with Tymoshenko: fresh charges are looming connected to a criminal case from the mid-1990s. No surprises that the criminal case is also related to the gas trade. This time round, though, Tymoshenko features not as the enemy of gas traders, but as one of the pioneers of the system, as head of gas trader United Energy Systems of Ukraine (UESU) in the 1990s - a company that allegedly ran up half a billion dollars in debt to Russia's defence ministry and then transferred the liability to the Ukrainian budget. Tymoshenko is not the first to be charged in connection with this: former prime minister Pavlo Lazarenko, widely regarded as the patron of UESU when he was in office, is already languishing in a Californian jail on a nine-year sentence for related embezzlement charges.

The smell of gas in Ukraine appears to be more than the sign of a leak - it's the smell of corruption and trouble ahead.

The smell of gas in the courtroom

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