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