C O N F I D E N T I A L SECTION 01 OF 03 KIEV 000337

SIPDIS

E.O. 12958: DECL: 01/25/2016
TAGS: ENRG EPET PREL PGOV RS UP
SUBJECT: UKRAINE: OUR UKRAINE'S BEZSMERTNY ON WHY THE
JANUARY 4 GAS DEAL IS GOOD FOR UKRAINE

REF: KIEV 280

Classified By: Ambassador, reason 1.4 (b,d)


1. (C) Summary: In a January 19 meeting with Ambassador,
Roman Bezsmertny, campaign chief for President Yushchenko's
party People's Union Our Ukraine, spun the January 4
Ukraine-Russia gas agreement as an advantageous deal for
Ukraine. On a macro level, the higher prices would force
necessary restructuring on Ukrainian industry that the
Government of Ukraine (GOU) would have had a hard time
implementing on its own; Gazprom would serve as a convenient
scapegoat. Monopolies of any sort, including Naftohaz, were
bad for the economy, and the creation of a joint venture
between Naftohaz and RosUkrEnergo (RUE) was the first step in
creating checks and balances in the gas sector. Bezsmertny
claimed the terms of the deal would give Ukraine an extra 20
billion cubic meters of gas in payment for transit, which
could be re-sold at market prices for further revenue gains.
Pre-election politics prevented Yushchenko from plugging the
deal along the lines of his analysis, he claimed. Whether or
not Bezsmertny's math adds up or his predictions come true,
his take on the deal may help explain why Our Ukraine
insiders do not see the January 4 deal as a catastrophe for
Ukraine's national interests. End summary.

Crisis? What gas crisis?
--------------


2. (C) Wielding his trademark acid tongue, Yushchenko party
campaign chief Roman Bezsmertny discussed with Ambassador
January 19 the January 4 Ukraine-Russia natural gas deal.
(Bezsmertny's comments on domestic political dynamics were
reported reftel.) Bezsmertny averred that there was no
longer any crisis over gas. The stand-off with Russia and
the resulting agreement had been an opportunity to change
public perceptions about who was responsible for gas pricing.
It also drove home the need to improve energy efficiency and
restructure industrial input pricing. Ukrainians did not
seem aware prior to the crisis of the monopoly status

Naftohaz enjoyed on gas distribution, Bezsmertny mused. Nor
did they realize that it was not the Government of Ukraine's
responsibility to set the price of gas. (Note: On Ukraine's
domestic market, gas prices are set by the National
Electricity Regulating Commission.)

Forcing industrial restructuring (and blaming Gazprom)
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3. (C) Bezsmertny said he had bluntly told leading
industrialists, including Serhiy Taruta, oligarch boss of the
Industrial Union of the Donbas (IUD), earlier on January 19:
Don't blame Yushchenko for $95 gas. The alternative was
Gazprom's $230 gas, not the old $50 price. Industrialists'
complaints came as no surprise; businessmen were focused on
the bottom line, and higher gas prices meant lower profits.
However, Ukraine's industrialists had previously based their
business plans on completely unrealistic input costs. They
needed to adjust; otherwise, competition from more efficient
producers would crush them. "I told Taruta he should
capitalize on this opportunity, or expect to see Mittal
(recent buyer of Ukraine's largest steel works) to become the
steel monopolist for Ukraine," said Bezsmertny. The five
years of the agreement would serve as a transition period.


4. (C) Bezsmertny claimed that, in terms of forcing the pace
of restructuring, an interim price of $120, rather than $95
would have been more effective. There was no other mechanism
available to the GOU to force change besides the price
mechanism; both President Yushchenko and PM Yekhanurov
understood this clearly. The GOU needed to overhaul the
price structure of utilities/communal services, combined with
compensation for pensioners and other vulnerable segments of
the population. The genius of taking advantage of Gazprom's
power play, noted Bezsmertny, was that the GOU could pin the
blame for the pain of restructuring on Gazprom/the Kremlin,
and facilitate change that the GOU by itself would not have
been able to force onto industry.

Turning off selected valves to force payment
--------------


5. (C) Bezsmertny claimed that the New Year's showdown had
played into Ukraine's hands in collecting tardy payments for
gas supplies already taken but not yet paid for, as well as
in managing industrialists' price expectations. Drawing a
rudimentary pipeline diagram, Bezsmertny said that there had
been no New Year's Day drop in the pressure along the main
pipeline, because the pressure had to remain the same at the
Russian and Polish borders. However, Naftohaz Chair Ivchenko
"fulfilled his tasking perfectly" by temporarily cutting off
supply to enterprises behind on payments. They immediately
paid up, and their gas was restored. In the past, when
Ukraine paid $50 for Turkmen gas at the Turkmen border, the
price to internal Ukrainian enterprises was $160. In their
own minds, with a rise to $95 under the January 4 deal,
industrialists feared the price of delivered gas would soar
above $200, even if that would not be the case. Ambassador
asked why Naftohaz had not forced repayment earlier;
Bezsmertny again cited the "blame Moscow" opportunity to
deflect blame away from Ukrainian authorities.

Will $95 hold for five years? No, but politics is politics
-------------- --------------


5. (C) Bezsmertny said that there was no implied obligation
for the price of gas under the January 4 deal to stay at $95
for five years and suggested no one should expect it to stay
at $95. That price was simply an orientation figure; the
final price would depend on contracts. Ambassador asked why
Yushchenko and Energy and Fuels Minister Plachkov had said
publicly that the price would remain the same. Bezsmertny
replied that Yushchenko understood the reality but had to
manage expectations in the run-up to the March 26 elections.
Bezsmertny accused a range of Ukrainian politicians of having
meddled in the negotiations with Russia by traveling to
Russia in December and meeting with Russian officials; Party
of Regions leader Yanukovych, Rada Speaker Lytvyn, and even
ex-PM Tymoshenko in an unpublicized trip in the December
26-28 timeframe, days before the New Year's gas crisis. They
had been a "fifth column" undermining Ukrainian national
interests.

Who benefits from RosUkrEnergo and the contract?
-------------- ---


6. (C) Ambassador emphasized our disquiet with RUE's role.
The West had supported Yushchenko because we thought he
represented something qualitatively new for Ukraine. RUE
epitomized the old nontransparent, corrupt way of doing
business. The U.S. understood that Ukraine felt it had to
accept RUE's role to reach agreement with Russia. But other
elements of the January 4 deal also were disturbing,
including the proposed joint venture. It would be critical
that the joint venture be transparent.


7. (C) Ambassador asked Bezsmertny which Ukrainians benefited
from RUE, and passed a list of surnames bandied about in the
Kiev rumor mill: (Petro) Yushchenko (the President's
brother), Naftohaz chair Ivchenko, former senior presidential
aide Tretyakov, and the brothers Vasyunnyk (deputy
Presidential Chief of Staff Ivan and his brother, recently
appointed to the Naftohaz board). His balding pate
reddening, Bezsmertny waved off the list and claimed reality
was simpler, and driven from the Russian side, which accrued
the real benefits from RUE and could set terms for the basis
of a supply agreement. Bezsmertny suggested Russian
President Putin and the Russians benefiting from the new
higher price would turn around and try to "buy Ukrainians"
politically. Bezsmertny claimed he had told Russian
Ambassador to Ukraine (and ex-Gazprom Chair) Chernomyrdin
that Ukraine would ignore whatever happened on the Russian
side of the border in terms of management and payoffs. The
GOU task was to ensure no theft of resources occurred within
Ukraine. Returning to the list of alleged Ukrainian
beneficiaries, Bezsmertny argued that if the list were
accurate, Our Ukraine would have no problems financing a
winning Rada campaign; it simply was not true. (Note: For
Bezsmertny's political assessment, see reftel.)


8. (C) Bezsmertny claimed that on December 29, the Russians
had essentially proposed a $270-million bribe to Yushchenko
to cut a deal on Russian terms; Yushchenko rejected it.
Putin called back "within 20 minutes," offering a Russian
loan to pay for the higher gas prices. Yushchenko took
offense, setting the stage for the January 1 showdown and the
subsequent January 4 agreement.

Joint Venture is good: will break monopolies, bring profits
-------------- --------------


9. (C) In contrast to the near universal condemnation of the
proposed joint venture between Naftohaz and RosUkrEnergo
(RUE) in the January 4 deal, Bezsmertny lauded the benefits
Ukraine would accrue from its establishment. He claimed that
as a result of the changes in the agreement for gas and
transit pricing, Ukraine would actually receive 20 billion
cubic meters more under the new deal (50 billion as opposed
to 30 billion in 2005). That difference could be re-exported
to Europe at the higher market price of $230, helping offset
the higher cost of gas overall. Ambassador asked Bezsmertny
why GOU leaders did not advertise this supposed advantage.
Bezsmertny replied in a cynical tone: "Because gas is all
about theft and con games (vorovstvo i obman, in Russian),
and manipulation of monopolistic advantage."


10. (C) Bezsmertny claimed that the GOU needed to create
competitive checks and balances within the Ukrainian gas
system, because as long as all aspects of the gas system were
under one roof at Naftohaz, monopolistic corruption and
bribe-taking were inevitable. The joint venture was only the
first step to open up the sector. There needed to be new
actors like UkrHazDobichie (Ukrainian Gas Supply),
UkrHazTransit (Ukrainian Gas Transit), and UkrHazProm
(Ukrainian Gas Industry) and other spin-offs, whose
self-interests could check each other, creating more of a
market. Bezsmertny emphasized that Yushchenko supported
efforts to use market mechanisms; Tymoshenko's natural
inclination was to use administrative measures or "London"
(note: a reference to gas trader Itera, with whom Tymoshenko
is alleged to have enjoyed a close relationship).

Fuzzy Math?
--------------


11. (C) Comment: As intriguing as Bezsmertny's macroeconomic
rationale may appear in arguing why the January 4 deal was
good for Ukraine, some of his numbers do not appear to add
up. If Ukraine received the $2.5 billion in transit fees
Ivchenko has announced, it would be able to purchase about 26
bcm at $95/tcm. For Ukraine to get Bezsmerty's 50 bcm,
Ukraine would have to negotiate a purchase price of $50/tcm.
Party of Regions deputy Volodymyr Makeyenko, a former gas
trader himself, predicted to us January 25 that the new price
of gas delivered to Ukrainian enterprises would be about $120
per thousand cubic meters. While prices differ per type of
user and rose throughout 2005, the average price for private
industry previously was roughly $75/tcm plus transport, not
$160 as Bezsmertny claimed.


12. (U) Visit Embassy Kiev's classified website at
www.state.sgov.gov/p/eur/kiev.
HERBST