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Ukraine, the Real Crisis on Russia's Doorstep

Last month NATO allies met in Bucharest and talked about the membership applications from Ukraine and Georgia. It was the latest episode in an 11-year-old courtship between the Western military alliance and the two former Soviet republics that Russia still sees as part of its orbit.

But NATO would have done more for Ukraine's - and Europe's - security if it had insisted that Ukraine reform its energy sector. Just one month after the Bucharest meeting, Ukraine is mired in its third annual natural gas contract dispute with Russia's state gas company, Gazprom, and the dispute is threatening supplies for much of western Europe because Russia's main pipeline to Europe transits Ukraine.

Reports from Europe today say that gas deliveries to Europe may have come to a complete halt; Russia and Ukraine are blaming each other for the disruption. This will undoubtedly bring a wry smile to the faces of conservatives who in the 1980s warned Europe against relying too heavily on Russia for natural gas supplies. President Reagan tried to stop the pipeline project back then. Back in 1982, an American Enterprise Institute report warned that the Soviet pipeline would be a "steel noose" that would create the potential for "economic blackmail."

Whether the current showdown is a contract dispute or economic blackmail isn't clear. It might be the former.

Nonetheless, if ever there were an example of how security cannot depend on military might alone, this is it. Ukraine's economy has been closed to outside investors eager to get into the natural gas supply and distribution business. Its dealings with Gazprom have been complicated by the role of RosUkrEnergo, a middleman company which appears to have little purpose other than siphoning off some of the money paid for natural gas.
Ukraine's energy-inefficient industries increase the need for supplies from abroad. And the country has done nothing to diversify supplies, preferring to rely on purchases from Russia at prices that remain below world market levels.

A December report by the International Monetary Fund said, "Consumers in Ukraine now pay only 10-40 percent of the international price of gas. This subsidization encourages overuse (Ukraine is among the world's least energy-efficient countries), expands the need for very costly imports, and through the required budget subsidy (or unpaid taxes) distorts spending and taxation." Ukraine uses more energy per unit of GDP than almost any other nation in the world and more than two and a half times as much as the average of the OECD nations. Now Ukraine has promised to bring domestic energy prices in line with international costs, but that will fuel inflation and will only be phased in over three years or so.

This energy mess couldn't come at a worse time for Ukraine's economy or the economies of Eastern Europe. In November, with the international financial crisis hammering Ukraine, the IMF extended a $16.4 billion line of credit to help restore stability. But a recent note by Erik Berglof, Chief Economist of the European Bank for Reconstruction and Development, warns that the IMF package might not be enough. "Ukraine is heading toward a twin currency and banking sector crisis that could well bring down most of the economies of Eastern Europe," he writes. Rapid currency depreciation is threatening the banking system because many firms borrowed in dollars. A few Western banks, mostly from the European Union, have major exposure in Ukraine, he notes, and that could spread the ill effects around the region.

Moreover, Ukraine faces massive debt rollover perils in 2009. As much as $41.5 billion (roughly 35 percent of GDP) external amortization payments are falling due,and refinancing in the current financial climate will be difficult, or at least costly.

Finally, Ukraine's GDP is expected to drop between 3 percent and 10 percent in 2009, Berglof says in the memo. And that could roil Ukraine's domestic politics in ways that might not be favorable to democracy and rapprochement with the West. "Securing a stable and democratic Ukraine, a country of 46 million people in the heart of Europe, is squarely in the interests of the United States and Ukraine's European neighbors," he wrote. "The progress in political and economic transition since the Orange Revolution in 2004 is being put at risk."

So this week's spat with Russia over natural gas supplies and prices may simply be the opening act in a year of pain and drama in Ukraine. And NATO membership would be no cure.

For more on RosUkrEnergo, see an article I wrote a couple of years ago.

Read the IMF report on Ukraine's economy here.

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Comments (5)

Wallenstein Author Profile Page:

Though I have strong ties to the Ukies, I have no sympathy for them in this case. The recent and current gas crises should have been foreseen over 15 years ago.

Ukraine finds itself in the same boat as Germany at the end of the 19th and early 20th centuries, burgeoning industry with few domestic sources of fossil fuels. What did Germany do? It embarked on research into energy efficiency and alternate sources that have turned Germany's obsession with energy efficiency into an almost comical stereotype. And the Germans have been pounding on Ukraine's doors for the last 15 years, too, ready to invest, invest, invest new capital literally everywhere.

wimroffel Author Profile Page:

What I miss in the article is the link with the oil price. A considerable part of the gas is used for electricity production and there it is in direct competition with oil. One would expect gas to demand a light premium over oil with the same energy content as it produces less pollution and less CO2.

Gas was and still is a very restricted market where both suppliers and buyers have very few options. But as more pipes are being built and more LNG installations are being built it is slowly developing into an open market just like oil.

yarikoptic Author Profile Page:

BTW -- here are the prices USA pays for the imports:

so 10.80$ per thousand feet^3 is approx 381$ per thousand m^3

so 450$ comes closer to the 'states price' ;-)
especially if we look at the LNG (Liquefied Natural Gas) -- 12.34$ per 1000 feet^3 is approx 435$ per 1000 m^3.

So at that price I guess Ukraine can well buy LNG after infrastructure gets build to accept it ;-)

yarikoptic Author Profile Page:

I was wondering myself where is 'europian price of 450$' comes from?

apparently so far I can say that 'out of the blue'

not sure how reliable digits are in
which is a year old also
but "the European price is the price of natural gas which is defined on the border of Germany and Poland, from which the transportation costs deducted. Today, this price is around 250 dollars. It is expected that the price of European borders by 2009 will be about 300 dollars."

Also article shows the reason for 'discounts' for the 'neighbors', such as Belarus and Armenia ;-)

yeolds Author Profile Page:

Would be interesting to know what is the rate for gas for Ukraine from Gazprom as compared to the price Germany pays for the same gas - with or without the extra transportation costs.
Without information as cited above it is difficult to make rational judgements on the situation. If I recall correctly in the last Ukraine/Gazprom dispute Ukraine received gas well below the EU rpice.
Look forward for illunmination

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