UKRAINE: OUR UKRAINE'S BEZSMERTNY ON WHY THE

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) -------------- -------------- ¶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