UKRAINE: NEW ENERGY MINISTER TOUTS WESTINGHOUSE-ENERGOATOM

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SUBJECT: UKRAINE: NEW ENERGY MINISTER TOUTS WESTINGHOUSE-ENERGOATOM
CONTRACT AS A DELIVERABLE

Treat as Sensitive but Unclassified. Not for Internet.


1. (SBU) Summary: New Energy Minister Yuri Prodan told the
Ambassador on January 21 that the GOU hoped to use a possible visit
by President Bush in the near future to sign a contract with
Westinghouse for the delivery of fuel to Ukraine's nuclear reactors.
Acknowledging that the contract proposed by Westinghouse to
state-owned nuclear utility EnergoAtom was complex and new for
Ukraine, Prodan nonetheless was confident that negotiations could be
completed in time for a possible POTUS visit on the margins of the
Bucharest NATO summit in April. The Ambassador agreed that a POTUS
visit would be an ideal backdrop for such a landmark signing, and
emphasized that no discussion on such a visit had yet been made, but
said negotiations should move forward independently of a possible
visit. Prodan also said that Ukraine must remove intermediary
RosUkrEnergo (RUE) from its gas dealings with Russia, but in the
short run had no alternative to RUE because Ukraine could not yet
pay the world prices that Russia would demand in direct
negotiations. The new head of NaftoHaz did not negotiate gas or
transit prices during his recent trip to Moscow, Prodan told the
Ambassador. On other topics, Prodan gave his backing to the oil and
gas exploration agreement signed by the previous GOU with U.S.-based
Vanco, said Ukraine needed to bring municipal heating prices in line
with true costs, and came out in favor of large-scale privatization
and restructuring of the electricity market in Ukraine. He was
non-committal when the Ambassador urged him to keep plans for a
central nuclear waste storage facility on track.


2. (SBU) Comment: The surprise statement linking the
Westinghouse-EnergoAtom deal to a POTUS visit shows that the new GOU
is keen to provide incentives for President Bush to come to Ukraine
in the near future. It remains to be seen whether the GOU and
EnergoAtom can sift through, negotiate and conclude a complex
commercial contract by the self-imposed April deadline that Prodan
mentioned, especially as there are likely still some in Energoatom
who oppose the deal. The new minister's comments on RUE do not
differ in substance from those of former Minister Boyko, and reflect
the view that gas bought from the intermediary still remains cheaper
than gas Ukraine buys directly from Russia. The economic rationale
for RUE will soon disappear as the prices Ukraine pays for imported
gas approach European levels. Prodan generally has moderate
pro-reform credentials on account of his previous track record in
the energy sector and his lack of cozy ties to many of the more
nefarious players in the sector, although his ties as a deputy to
former Minister Plachkov (who was in charge during the January 2006
gas deal) do not inspire great confidence in us. End summary and
comment.

Westinghouse-EnergoAtom Contract a POTUS Deliverable?
-------------- --------------


3. (SBU) During their January 21 introduction meeting, Minister of
Fuel and Energy Yuriy Prodan told the Ambassador that the new GOU
hoped to use a possible visit by President Bush in the near future
to sign a contract between Westinghouse and EnergoAtom for the
delivery of nuclear fuel. Prodan and his deputy Yuriy Nedashkovsky
made the comment after the Ambassador applauded Prodan's recent
public statements of support for the Ukraine Nuclear Fuels
Qualification Project, in which Westinghouse fuel, with USG support,
is being qualified for usage in Ukraine's Russian-built reactors.
Prodan said cooperation with Westinghouse would help Ukraine
strengthen energy security by allowing it to diversify its sources
of nuclear fuel, all of which currently is purchased from Russia.
With the qualification project moving forward, the state-owned
nuclear utility EnergoAtom was making progress negotiating a
commercial contract over the supply of fuel with Westinghouse.
Deputy Minister Nedashkovsky said the contract was the first of its
kind for Ukraine; it was far more complex than the agreements
EnergoAtom had with Russia and was being examined carefully.
However, the GOU was keen that it be ready for signing should
President Bush visit Ukraine in April before or after the NATO
summit in Bucharest, and had given instructions to EnergoAtom to
expedite the negotiations with Westinghouse. Prodan expressed
confidence that the timeline could be met despite these
complexities.


4. (SBU) The Ambassador praised the GOU's proactive determination to
accelerate the fuel qualifications project (which met some
resistance under the previous government),and said the USG was
willing to support the parties as they negotiate the commercial
aspects of the cooperation. The signing of the commercial contract

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during a presidential visit would be a major economic and political
success story. The Ambassador said he would welcome a visit by the
President, and said the proximity of the Bucharest summit could
provide an opportunity. He added, however, that there were still no
concrete plans, and encouraged Prodan to move forward on the
Westinghouse deal independently of a possible visit.

Prodan: No Alternative to RUE in the Short Term
-------------- --


5. (SBU) Prodan told the Ambassador that Ukraine needed to move
towards market conditions in its gas dealings with Russia. That
would allow Ukraine to negotiate directly with Russian suppliers and
eliminate middleman RosUkrEnergo (RUE). In the short term, however,
Ukraine still had no option but to use RUE. The intermediary
purchased central Asian gas and sold it to Ukraine at prices that
remained lower than those that Russia would charge Ukraine directly.
In bilateral discussions on the gas issue, Russia regularly said it
was ready to sell gas to Ukraine at the average price charged to
Europe minus the transit fee, but Ukraine still could not pay such
prices, Prodan said.


6. (SBU) The problem, he told the Ambassador, was that the Ukrainian
economy still could not absorb a sudden rise in the price of gas to
European levels. Before getting there, Ukraine needed to further
modernize its economy, improve energy efficiency and develop more
domestic energy sources. The new government would need to determine
the timing and the path towards full market relations with Russia
over gas, but "the sooner the better," he said. Any discussions
over market prices for gas would invariably lead to new discussions
about the proper transit fee for Russian gas crossing Ukraine to
Europe. The price for imported gas would continue to rise in the
coming years and soon reach world levels. In the meantime, there
was no other option to the middleman solution which provided
affordable gas, he maintained.

NaftoHaz
--------------


7. (SBU) Responding to a question by the Ambassador, Prodan said
that new NaftoHaz Chairman Oleg Dubyna did not travel to Moscow on
January 17 to negotiate prices for gas imports or for transit fees.
Prodan said the new government "was eager to learn what is happening
inside NaftoHaz," the state-owned gas and oil company that might be
on the verge of bankruptcy. The GOU has established an interagency
committee to look into all aspects of the company's operations. The
new government was acutely aware that many across the world were
following the developments surrounding NaftoHaz on account of the
importance of its gas transit network for Europe. Hence making
NaftoHaz transparent and accountable was a priority for the new
government and his ministry, he said.

Other topics
--------------


8. (SBU) On other topics, Prodan:

-- said new Deputy Prime Minister Vitaliy Haidyuk would cover
industrial and economic policy as well as energy. Both NaftoHaz and
EnergoAtom will be subordinated to the Ministry of Energy, although
the CabMin will control the hiring and firing of the chairmen of the
two companies and their deputies.

-- reiterated support for the production sharing agreement with
U.S.-based Vanco.

-- criticized the current practice of selling gas to municipal
utilities far below cost. Ukrainian policy was still hamstrung by
the idea that domestically produced natural gas, because it was
cheaper than imported gas, should somehow be sold to municipal
utilities at prices far below market rates. Such thinking was
bankrupting NaftoHaz and retarding the development of domestic
natural gas supplies. The GOU would need to insulate the population
from rising energy prices by targeted subsidies.

-- confirmed that the GOU planned to privatize more regional power
distribution companies (Oblenergos). He also said Ukraine should
begin privatizing power generation companies as well, particularly
since "shadow privatizations" were already taking place. Further
administrative regulatory and legislative steps were necessary, he
said, to create the proper regulatory environment for a power sector

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based on private players.

-- gave his support, in principle, for the construction of a central
storage facility for spent nuclear fuel, but otherwise remained
non-committal when the Ambassador asked for his engagement to keep
the project on track. (Note: U.S.-based Holtec won the tender, but
progress on the project has been slow. End note.)

-- said he backed plans, developed with U.S. DOE assistance, for the
disposition of highly enriched uranium currently stored at research
institutes in Kyiv and Sevastopol. The National Security and Defense
Council still needed to approve the plan, he said.

-- said he expected draft laws introducing green energy tariffs to
be passed in the Rada. (Note: U.S. investor AES has been interested
in such legislation, as it would make wind energy investments in
Ukraine more viable.)

Taylor