On October 3, Ukraine and Russia signed a Memorandum of Understanding under which price increases for gas imports will be spread over three years. Although Kiev appears to have secured supply at a manageable cost, lack of detail in the agreement and turmoil in Ukrainian politics suggests the deal will have little impact in the long run.
Yulia Tymoshenko appeared to many observers to have scored several political and economic coups over the weekend. The "Orange Princess" and new darling of the Kremlin has negotiated a deal with Vladimir Putin under which the price that Ukraine pays for Russian gas will increase to European levels over three years, as opposed to a single hike from January 2009, as had been threatened. It is understood that the Memorandum of Understanding which the two parties signed entailed prices rising to 80% of current EU prices next year, 90% in 2010 and finally 100% in 2011. This will be made possible through two related policies.
Firstly, transit fees for gas being forwarded on to Europe will rise, partially compensating for Kiev's higher costs. Secondly, the new deal will cut out RosUkrEnergo - a murky Swiss-registered intermediary which is part-owned by Gazprom and had enjoyed exclusive supply rights to Ukraine since 2004. This deal in turn required Kiev to settle RosUkrEnergo's $2.2 billion debt to Gazprom, which Ms Tymoshenko plans to achieve through the sale of the firm's underground reserves.
On the face of it, this seems like a continuation of an already good deal for Kiev, negotiated by a shrewd politician whose experience in gas trading during the early 1990s is now reaping benefits. Ukraine's economy would clearly suffer immensely were prices to go from the current $179.5/1,000m3 to the almost $500/1,000m3 which Europe endures, overnight. Furthermore, in squeezing RosUkrEnergo out of the value chain, supplies to Ukraine and Europe will become cheaper and more reliable. However, an unsettled reality belies this rosy picture.
To begin with, the exact price has not yet been agreed. Although Ukraine currently imports gas from Russia at just under $180/1,000m3, end users actually end up paying something approaching $250/1,000m3 on account of transit fees and VAT. Anything beyond $400/1,000m3 would likely cripple Ukraine's economy, especially in light of the plummeting value of the national currency, the hryvnia. Steel accounts for 27% of the country's GDP, 40% of the export currency inflows, and 12% of the tax collection alone, but with such high gas prices (not to mention Chinese competition) the industry will become unviable. So even if the new MOU cushions the blow to Ukraine's economy, it will still represent an unsustainable increase in energy prices.
Secondly, whereas the price of gas which Europe pays is set by the market (and is essentially index-linked to the price of oil) Ukraine's price is effectively agreed on a 12-month flat rate basis. This is tantamount to Kiev gambling on year-ahead prices, at a time when it is unclear which direction oil markets will go. If they were to continue bearish trends to below $70 a barrel in 2009, Ukraine could find itself paying substantially over the odds for its gas.
A third and decidedly indeterminable factor is the impact of domestic Ukrainian political wranglings on Russia's decision to honor agreements. Yulia Tymoshenko's coalition of Orange Revolution allies collapsed on September 16, largely as a result of long-standing acrimony between herself and her rival Viktor Yushchenko, catalyzed over reactions to the Russia-Georgia conflict. Mr Yushchenko energetically backed Tbilisi and has since sought to accelerate Ukraine's push towards NATO and constrict the freedom of Russia's fleet at Sevastopol. Conversely, Ms Tymoshenko has sought to avoid provoking Moscow, hence the meeting with Mr Putin and subsequent MOU. The collapse of the government means that Ukrainian politics will remain in flux for the next three months until pre-term elections.
Ms Tymoshenko is far more popular than Mr Yushchenko in national polls but the implosion of her coalition means there is a possibility that Mr Yushchenko will emerge in a stronger position in the medium term. Mr Yushchenko loathes Mr Putin and perceives Russian foreign policy as aimed at undermining Ukrainian stability as far as possible. Given the poisonous relations between the two, and Gazprom's manifest willingness to renege on existing agreements, this new MOU hardly seems worth the paper it's written on.