UKRAINE: 2008 GAS NEGOTIATIONS UNDERWAY--NOTHING

C O N F I D E N T I A L SECTION 01 OF 02 KYIV 002832 SIPDIS SIPDIS DEPT FOR EUR/UMB EEB/EEC/IEC-GALLOGLY/WRIGHT DOE FOR LEKIMOFF, CCALIENDO E.O. 12958: DECL: 11/17/2017 TAGS: ENRG EPET ETRD PREL PINR UP SUBJECT: UKRAINE: 2008 GAS NEGOTIATIONS UNDERWAY--NOTHING SIGNED YET Classified By: Ambassador for reasons 1.4 (b) and (d) ¶1. (SBU) Summary. 2008 Gas Negotiations between Ukraine and Russia continued in Moscow this week. Ukrainian Minister of Fuel and Energy Yuriy Boyko announced in the press that natural gas pricing negotiations with Russia's state-owned gas company, Gazprom, that Ukraine would pay close to $160 per thousand cubic meters (tcm). Gazprom officials, however, underlined on more than one occasion in the press that nothing had been signed yet, and negotiations are still underway. The Ukrainian press and our contacts in the Ministry of Fuel and Energy reported that the Russians are waiting to see if a new Ukrainian government will be formed before agreeing on a price. Tentative other outcomes of the negotiations predicted in Kyiv include: the infamous gas intermediary RosUkrEnergo (RUE) remains as part of the deal for at least 2008, and the Ukrainians hope to get an increase in gas storage fees. The Russians reportedly did not show flexibility in Ukrainian proposals for increased transit fees, however. The Russian side also has reportedly proposed a glide path to bring gas prices close to European levels by 2011, when they also will eliminate the price differential for Russian domestic customers. End Summary. Boyko Busy in Moscow -------------- ¶2. (SBU) Minister of Fuel and Energy Yuriy Boyko has been racking up frequent flyer miles to Moscow since early October to negotiate with the Russians. Despite some press accusations that Boyko may be in the pocket of the Russians, Boyko has maintained that his primary goal in negotiating a gas price with Gazprom was to get the lowest price possible, and he did not feel that yearly negotiations or the middleman company RUE were necessarily negatives, if Ukraine came back with a low price. A Good Price for Ukraine? -------------- ¶3. (C) Since the beginning of 2007, Boyko has speculated on a gas price for 2008. Boyko's early predictions ranged from $130 to $190, while lately he has been predicting prices in the range of $150 to $160. U.S. energy advisors have calculated that Ukraine actually pays closer to $192 tcm because Ukraine also has to pay for an additional 15 bcm of gas that goes to RosUkrEnergo, besides the roughly 50 bcm Ukraine imports for its own use. If these calculations are correct, it appears the Ukrainian economy has been already shouldering a gas price of $192 per tcm, so an increase to the presumed Gazprom price of $230 would be not so as difficult to manage under current economic conditions as many presume. Not Enough Time to Get Rid of RUE? -------------- ¶4. (SBU) On October 12, First Deputy Chief of Staff of the Presidential Secretariat Oleksandr Shlapak announced that President Yushchenko agreed not to eliminate the middleman company RUE from the current gas deal with Gazprom. Shlapak argued that Yushchenko simply does not have time to liquidate RUE, and the Ukrainians do not have a better alternative to offer the Russians. Shlapak announced that after negotiations, Ukraine will work toward 2009 agreements in which Ukraine will again move for the absence of a middleman company in a gas deal. Besides the lack of transparency and access to rents that a middleman company provides, energy experts also agree that RUE has siphoned billions of dollars away from Naftohaz, which is facing severe financial difficulty. Gas Storage Rates Might Increase, but Not Transit -------------- -------------- ¶5. (C) On gas storage rates, Fuel and Energy Deputy Minister Makukha told Econ Counselor November 15 that the Russian side was open to some increases by the Ukrainian side, provided the Ukrainian side could make a case that their costs (e.g., wages, electricity) are actually increasing. To date, Ukraine's regulator has increased storage rates for domestic users, but this has not been applied to foreign users thus far. However, Makukha noted that Russia was resisting any change in Ukrainian transit rates. The Ukrainians, Makukha KYIV 00002832 002 OF 002 said, recognize any increase will come out of Gazprom's bottom line in its agreements with Western Europeans. The Ukrainians hope Gazprom will increase those rates eventually to leave room for eventual increases in Ukrainian transit rates. No Final Deal - Let's Wait to See Who's in Charge -------------- -------------- ¶6. (C) Makukha noted the Russians were also pressing to have Ukraine agree to a scheme of price increases up to the year 2011, when Russian domestic prices are to be in the range of European prices, less transit costs. He felt this price increase was likely inevitable, but the Ukrainians were wary of making a commitment without more clarity on the basis for this price increase scheme. Makukha reiterated a point made before by Boyko -- the Russians will hold off any final deal until they see who will become Ukraine's Prime Minister. He implied that if Tymoshenko becomes PM, the Russians might not stick to the price levels they have been discussing to date. ¶7. (C) Comment. As negotiations move forward, we suspect a gas price increase of about $30 for 2008 is plausible, but by no means a foregone conclusion. It appears the Ukrainians have not employed any new strategies in their negotiations that would allow them to increase transparency or move to predictable, long-term pricing for gas. As in the past, the GOU has eschewed a long-term approach in favor of the traditional ad hoc approach to gas negotiations. As in 2006, this leaves them in an exposed negotiating position -- they still have no agreement with the year end and the coldest winter months approaching rapidly. Taylor