UKRAINE: RESOURCE NATIONALISM REPORT

C O N F I D E N T I A L SECTION 01 OF 02 KYIV 002820 SIPDIS SIPDIS DEPT FOR EUR/UMB, EEB/EEC/IEC-GALLOGLY/WRIGHT EEB/ESC/IEC/EPC BGRIFFEN DOE FOR LEKIMOFF, CCALIENDO E.O. 12958: DECL: 11/13/2017 TAGS: EPET ENRG ETRD PREL UP SUBJECT: UKRAINE: RESOURCE NATIONALISM REPORT REF: STATE 150999 Classified By: Ambassador for reasons 1.4 (b) and (d) ¶1. (C) Summary: Ukraine has relatively small reserves of oil and natural gas, but is the world's largest hydrocarbon transit country, moving 75.8% of Russia's natural gas to Europe. Ukraine imports 77% of its natural gas and 79% of its oil needs almost exclusively from Russia. As a legacy of Soviet practices, some Ukrainian policies in domestic resource development exhibit some features of resource nationalism as defined in reftel. If anything, Ukraine's need to diversify sources of energy supply are weakening this resource nationalism. End summary. ¶2. (C) The Ministry of Fuel and Energy of Ukraine exercises control of the energy sector via state-owned companies, most under the aegis of the oil and gas company NaftoHaz Ukrainy. NaftoHaz and related companies have traditionally controlled upstream production and exploration for hydrocarbons. Although foreign companies have been allowed into these activities, they have found the Ukrainians unwilling to allow large-scale foreign participation in practice, as companies run into a myriad of licensing, pricing, and other barriers. In addition, oil and gas pipeline operations remain state monopolies under NaftoHaz. Ukrainian law forbids any sale of pipeline assets, which most believe is an effort to prevent Gazprom or other Russian entities from taking over Ukraine's gas transit assets. On the other hand, downstream activities in Ukraine have long been open to foreign investment. There is significant (mostly Russian) investment in Ukrainian refineries, oil retailing, and gas distribution. NaftoHaz is widely regarded as very corrupt, with shady side deals, kickbacks, and featherbedding that allow a number of its employees to enrich themselves. This corruption may be a motivation for keeping foreigners at bay, as those involved see foreigners eating into their potential take. ¶3. (C) One particular recent GOU policy that might be defined as an example of resource nationalism is the January 2007 Cabinet of Ministers Decree #31. Via this decree, the GOU requires all gas companies that are 50% or more owned by the state (including joint ventures and subsidiaries) to sell all domestically produced natural gas, except for gas used for technical needs, at a low state-regulated price. Recently, the U.K.-based company Cardinal Resources, which was in a joint venture with two Ukrainian state-owned companies, sold its Ukrainian assets to Kuwait Energy Company, claiming that Decree #31 had virtually bankrupted its Ukrainian venture because Cardinal Resources was unable to sell at prices above production costs. However, the underlying motivation for the decree seems to be to keep domestic gas prices down, thus keeping the population happy, and does not seem to be driven by a need to push foreign companies out. Moreover, it should be noted that under Decree #31, state-owned companies are also unable to sell their gas at market prices, which has contributed to financial difficulties for state-owned companies. ¶4. (C) At the same time, there has been a trend in the last few years toward more foreign investment and foreign business collaboration, and even some foreign ownership of energy companies over the last few years. The U.S.-based company AES, for example, since 2005 owns two regional electricity distribution companies and other distribution companies also have foreign owners. In October 2007, the Houston-based oil company Vanco signed Ukraine's first-ever production sharing agreement for oil and gas exploration in the Black Sea, and additional U.S. companies are currently engaged in study agreements for future oil and gas exploration with state-owned companies. In the nuclear sector, the Pennsylvania-based company Holtec recently signed a $250 million agreement to complete an Interim Spent Nuclear Fuel Storage Facility at the Chernobyl Nuclear Power Plant. In nuclear fuel supply, the nuclear generating monopoly Energoatom is negotiating with Westinghouse about providing fuel elements to some nuclear reactors. To date Ukraine has imported 100% of its nuclear fuel from Russia. ¶5. (C) What appears to be driving this liberalization is the imperative to bolster energy security by increasing domestic production through bringing in international expertise. The importance of energy security was brought home by Russia's gas shut-off in January 2006 in a pricing dispute. Since then, some senior leaders in the GOU recognize Ukraine needs KYIV 00002820 002 OF 002 to bring in foreign partners with the technology to address problems such as deep drilling onshore and exploring in the deep water of the Black Sea. This seems to be forcing Ukraine to move away from aspects of resource nationalism (or perhaps more accurately in Ukraine's case - resource cronyism) towards a more open attitude toward foreign participation in the energy sector. However, this opening is likely to move in fits and starts, as those in NaftoHaz who would like to keep the sector to themselves have not gone away and are likely to continue to seek to resist and undermine foreign participation in the sector. Taylor