RUSSIA USES GAS HIKE TALK TO TURN HEAT UP ON

C O N F I D E N T I A L SECTION 01 OF 03 KYIV 001544 SIPDIS SIPDIS DEPT FOR EB/ESC/IEC RGARVERICK DOE PLEASE PASS TO LEKIMOFF, CCALIENDO E.O. 12958: DECL: 06/26/2017 TAGS: ECON ENRG EPET PGOV PREL RS UP SUBJECT: RUSSIA USES GAS HIKE TALK TO TURN HEAT UP ON UKRAINE? KYIV 00001544 001.2 OF 003 Classified By: Ambassador, Reasons 1.4 b) and d). ¶1. (C) Summary. Russian President Vladimir Putin reawakened Ukraine's anxieties about future natural gas prices in his speech at the G8 summit on June 4, asserting Russia would no longer subsidize Ukraine's gas purchases. During the same week, Ukrainian Minister of Fuel and Energy Yuriy Boyko surprisingly announced the governments of Russia and Ukraine were preparing a new gas protocol that would give Russia exclusive access to Ukraine's gas transit system, while fixing a schedule for transit volume until 2030. In addition, Russia would guarantee supplies of gas to meet Ukraine's consumption needs until 2030. Boyko's proposal, obviously a trial balloon, faced criticism in the press and from President Yushchenko, and Deputy Prime Minister Klyuyev told Ambassador it was going nowhere. U.S. and Ukrainian energy experts agree Moscow's rhetoric has given Boyko an opportunity to press for acceptance of a deal that may keep gas prices increases moderate, but perhaps at a cost to Ukraine's control over its pipelines. End Summary. -------------- Moscow Explains New Gas Prices -------------- ¶2. (C) Russian President Putin caught the Ukrainian public by surprise with his statement at the G8 summit that Russia had been subsidizing Ukraine for years by selling natural gas at bargain prices. Two days later, Russian Ambassador to Kyiv, Victor Chernomyrdin, announced that Russia would indeed charge Ukraine higher prices of gas beginning in 2008. Chernomyrdin justified a price rise by citing higher demand, and asserted that the decision was based on strictly economic and not political grounds. (Note: Currently, Ukraine pays $130 per thousand cubic meters (tcm) of gas while the weighted average EU price is $270 per tcm. End Note.) ¶3. (C) Ukrainian energy experts Volodymyr Saprykin from the respected Razumkov Energy Center and Mikhailo Honchar from the Ukrainian-German Energy Forum told us their sources at Russia's Gazprom had claimed the new gas price for Ukraine could even be as much as 17% higher than the $270 price for Europe, allegedly to compensate for losses incurred in 15 years of subsidizing Ukraine's consumption. They said they expected a higher gas price, but doubted it would be higher than $270 per tcm. Saprykin and Honchar expressed concern that Fuel and Energy Minister Boyko had promised the public and industry that the gas price would either remain at $130 per tcm for the next two years or at worst be raised to $180 per tcm. Boyko, they said, would be forced to use all his remaining clout with Moscow to keep the gas price low, and would likely be negotiating with Russia all summer to secure an acceptable 2008 price. -------------- Ukraine's Reaction to Proposed Gas Price Hike -------------- ¶4. (C) Deputy Head of the Ukrainian Presidential Secretariat, Oleksandr Chaliy, countered Putin's rhetoric in SIPDIS the press by asserting Ukraine had effectively paid higher prices for gas than other European countries had in the past. Chaliy reasoned that by charging Russia cut-rate prices over the past 15 years for gas transit and underground storage fees, Ukraine was in effect paying a premium price for gas. Boyko characterized Putin's comments as political, explaining that the gas Russia delivered to Ukraine came from Central Asia, and that the price Ukraine paid for that gas was economically reasonable, not a subsidy. -------------- Boyko's Trial Balloon: A New Gas Protocol? -------------- ¶5. (C) On June 5, a draft gas protocol from the Ministry of Fuel and Energy between the governments of Ukraine and Russia was published on the Internet and circulated in newspapers. The Ministry of Fuel and Energy said the protocol was a genuine draft, but that there was no date set for the Cabinet of Ministers to consider it yet. (Note: While the draft protocol is intergovernmental, the actual terms--supply and transit quantities and prices--would be set down in commercial contracts, tied to the protocol guidelines, between Russia's Gazprom and Ukraine's NaftoHaz. End note.) KYIV 00001544 002.2 OF 003 ¶6. (C) According to the Ministry of Fuel and Energy Press Office, the draft protocol commits Russia to transit through Ukraine 125 bcm of gas per annum through 2013, and no less than 145 bcm/year from 2013-2030. Under the protocol, even if Russia builds gas pipelines that bypass Ukraine, Russia will still be committed to these transit amounts. ¶7. (C) According to the draft protocol, Ukraine is not allowed, however, to provide transit service for gas supplies other than Russian under the new protocol, even if there was available pipeline capacity. The draft protocol also commits Russia to guaranteeing sufficient gas deliveries to meet Ukraine's consumption needs, as specified in the commercial contracts between Gazprom and NaftoHaz. Furthermore, it allows Russia to pay for gas transit in gas rather than in cash. (Note: the January 2006 agreement between Gazprom and NaftoHaz did away with the practice of allowing in-kind payments for gas transit. End Note.) Finally, the draft protocol links the increases in the price of transit to increases in the price of gas, and stipulates that the protocol must be reviewed by both parties annually. ¶8. (C) In response to the appearance of the draft protocol in the press, Ukrainian President Victor Yushchenko maintained in a press conference that Ukraine was planning to increase Ukraine's energy security by diversifying its energy sources. He discouraged any new gas agreements that require annual renegotiation, calling instead for a long-term transparent agreement. On June 14, in the Ukrainian press, Prime Minister Yanukovych also stressed the importance of energy security and promised that Ukraine will not give up its ownership of gas transport lines to any other country. Finally, in a June 20 meeting, Deputy Prime Minister Andriy Kluyev told Ambassador that the draft protocol still required Cabinet Of Ministers approval, and scoffed at the suggestion that any such approval would be forthcoming. Econoff checked with Minister Boyko's staffer Oksana Hryshchenko on the status of the protocol. She confirmed the protocol had not yet received Cabinet approval, but noted it remained only a "working negotiating document." ¶9. (C) U.S. energy experts contacted by post characterized the protocol as an attempt by Boyko to cut a deal with gas price concessions from Moscow by now, while parliament and the executive branch are weakened. Ukrainian energy expert Mikhailo Honchar claimed to us that the Putin-Yushchenko Commission had agreed to draft a new gas protocol, but that Boyko, without the consent of the Ukrainian Cabinet of Ministers, was now trying to preempt that process by promoting his own draft. Both thought that Boyko saw the trepidation caused by Putin's remarks as an opportunity to float his Russia-friendly deal. Despite Boyko's enthusiasm for the protocol, we are unaware of any public mention of the protocol in the Russian press. Moreover, the Ukrainian Cabinet of Ministers has yet to approve the document. -------------- Private Effort to Expand Gas Pipeline? -------------- ¶10. (C) Rather than lock itself into business with Russia, Klyuyev reiterated the GOU had no intention of giving up control of its pipeline and rather was looking to find ways to expand capacity and attract new gas transit customers. Klyuyev reasoned Ukraine remains the shortest transit route to Europe for Russia and Central Asia and so Ukraine should use that comparative advantage. His idea is to attract private capital to build an expanded gas line alongside the current pipeline, where it could be built economically and without problems of land allocation. (Note: After talks in Moscow on June 23, Yanukovych noted that a decision on Russian participation in the hardy perennial project of expanding the Bohorodchany-Uzhgorod gas line might be taken in September. End Note.) ¶11. (C) Comment. We have consistently endorsed Ukraine's gradual adjustment to paying European-level prices for natural gas, and Ukrainian industries and even households have begun that process of adjustment. But a sudden doubling of the price as implied by Putin and Chernomyrdin would be a severe shock to the economy. From what post can determine, Boyko's draft protocol has not advanced beyond the trial balloon stage and its current prospects do not look strong. Those who suspect Minister Boyko might be busy trading away Ukraine's strategic interests in order to keep gas prices low KYIV 00001544 003.2 OF 003 have criticized of his proposal to give Russia de facto control over Ukraine's transit system--a prize Russia has long sought, although it would lock Gazprom into the Ukrainian pipeline, which might anyway be a difficult sell to the Russians. Boyko's apparent freelancing with this protocol proposal also illustrates a persistent problem in Ukraine's energy policy -- the GOU fails repeatedly to speak with a single voice on energy. This makes it difficult for all Ukraine's partners, including the Russians, to deal with them. End Comment. Taylor