UKRAINE: TYMOSHENKO PLEDGES NO GAS PRICE HIKE

C O N F I D E N T I A L SECTION 01 OF 02 KYIV 001487

SIPDIS

DEPT FOR S/EEE, EUR/UMB, EB/ESC/IEC
DOE PLEASE PASS TO JELKIND, LEKIMOFF, CCALIENDO
NSC PLEASE PASS TO KKVIEN

E.O. 12958: DECL: 08/30/2019
TAGS: EPET ECON EFIN ENRG EREL PGOV PREL PINR UA
SUBJECT: UKRAINE: TYMOSHENKO PLEDGES NO GAS PRICE HIKE

Classified By: ECON Counselor Edward Kaska for reasons 1.4 (b,d).


1. (SBU) Summary. At a road opening event in Western Ukraine
on August 25, Prime Minister Tymoshenko stated that gas
prices would not increase for the population this year.
Tymoshenko's statement appears to contradict her earlier
commitments to international donors to raise gas prices for
households 20 percent on September 1. Following Tymoshenko's
statement, trade unions, which must give approval under
Ukrainian law for any gas price increase, also stated they
would block price hikes. The 20 percent price increase for
consumers on September 1 would, in reality, raise little
extra revenue for cash-strapped Naftohaz but would signal
that Ukraine was prepared to undertake needed reforms.
Tymoshenko's statement raises concerns about the government's
commitment to agreed reforms among IFI and EU representatives
in Kyiv and shows that PM Tymoshenko is willing to gamble
that the IMF and other donors will allow her leeway in her
commitments to reform. End summary.


2. (U) In July Tymoshenko reached agreements with the IMF,
the EU, World Bank, EBRD, and EIB to raise gas prices by 20
percent on September 1 for household consumers and by 20
percent on October 1 for municipal heating companies. The
gas price increase was included as a condition for the
release of IMF's third tranche and a prior action for a $1.7
billion financing package being put together by the EU, World
Bank, EBRD, and EIB.


3. (SBU) On August 25 Prime Minister Tymoshenko was quoted in
local media as saying "Settlement for gas has been made to
the last kopeck and there will be no price rises for the
population." Tymoshenko was in Rivne, a western Ukrainian
town, to open a segment of the Kyiv-Chop highway.
Tymoshenko's declaration was carefully targeted to appeal to
western Ukrainian voters, a group Tymoshenko has been
courting. Kyiv-based International Center for Policy Studies
Director Olga Shumylo told us that any gas price increases
would be felt relatively more heavily in rural, including
western, Ukraine, where people purchase gas directly for
their home heating needs. In urban centers, such as Kyiv,
apartments are heated via central heating plants, and prices
for heat are calculated by the size of the apartment and
number of people registered to live there. Heating tariffs
are set by municipal governments, and it is uncertain whether
or how heating plants would pass on increased gas prices to
their consumers.


4. (U) Minister of Fuel and Energy Yuriy Prodan subsequently
stated on August 26 that he doubted there would be a gas
price increase for consumers on September 1. According to
Prodan, the gas price increase was not agreed to by the
Federation of Trade Unions of Ukraine, a requirement
established by a Cabinet of Ministers resolution in September

2008. The Cabinet of Ministers resolution requires the GOU
to obtain approval of the Federation of Trade Unions of
Ukraine and a corresponding association of employers for any
increase in gas prices.


5. (U) Vasiliy Khara, the head of the Federation of Trade
Unions and an MP from the Party of Regions, told the press
that the Federation had been passed a copy of the gas price
increase resolution from the National Electricity Regulatory
Commission only on August 27. Khara also stated that the
unions believe there are no "economically justified reasons"
for a gas price increase. Khara was quoted as saying the
unions are planning a strategy of protest actions to begin in
mid-December. Party of Regions' Viktor Yanukovych stated on
August 31 that the scheduled gas price increase should be
canceled.


6. (C) Kyiv representatives of the IMF, World Bank, EBRD, and
European Commission all told us that Tymoshenko's statement
was cause for concern, although some questioned if she indeed
meant what she was quoted as stating. The IMF's Resident
Representative Max Alier said that GOU officials had told the
IMF that Tymoshenko's statement was taken out of context and
that the GOU was ready to go ahead with the price increase.
The World Bank's Country Director Martin Raiser said that the
Bank would continue its work with the GOU to develop a
targeted subsidy program to ensure middle and high-wage
earners pay their share of gas prices, while continuing
subsidies to low-income earners. He expected this program to

KYIV 00001487 002 OF 002


be included in the 2010 budget but added that the
"backtracking" on prices would not make it easy to complete
preparation of the next Development Policy Loan. Hans Rein,
the European Commission's energy officer, told us that for
the EC the price reform was "critical."


7. (U) The World Bank's Senior Country Economist Pablo
Saavedra told us that Ukrainian households spend only 4
percent of their income on utilities, including heating and
gas payments. The 20 percent gas price increase for
consumers would therefore be largely symbolic, particularly
when coupled with a targeted subsidy program the World Bank
is developing in coordination with the GOU, and would not
dramatically affect Ukrainian rural or low-income consumers.
According to Saavedra Ukrainian household energy consumption
decreases by only 0.7 percent when energy prices increase by
10 percent. The Bank estimates that the two gas price
increases scheduled for this year would raise only an
additional 0.3 percent of GDP, or approximately UAH 300
million for Naftohaz. The gas price increases would do
little to relieve Naftohaz of its cash flow problems, but the
increases would signal that the GOU was finally prepared to
take the needed measures to reform its gas sector.


8. (SBU) Prior to Ukraine's agreements with the IMF, EU,
World Bank, EBRD, and EIB in July, Tymoshenko repeatedly
stated that gas prices would not increase before the
presidential elections. Tymoshenko claimed that the
population could not tolerate price increases due to the
economic crisis. Tymoshenko told Special Envoy for Eurasian
Energy Ambassador Morningstar in June that she feared any gas
price increase would result in lower payment collections and
could cause social unrest. Tymoshenko's statement on August
25, however, was the first time she said gas prices would not
go up since reaching the agreements with the IFIs and the EU.



9. (C) Comment. It is unlikely that the gas price increase
will take effect on September 1 as the GOU previously
pledged. Tymoshenko has shown she is reluctant to take tough
decisions which could then be used by her political opponents
against her. She has chosen instead to gamble that the IMF
and other donors will show her leniency. Too much leniency,
however, puts in jeopardy the hope that any reform will be
enacted. Already we have seen Naftohaz attempting to
restructure its international debt. Some speculate that if
it is able to do so, Ukraine may decide it has sufficient
funding on hand to forgo any additional IFI money and the
conditionalities attached to such money. Without reform, the
long-term financial stability of Naftohaz, Ukraine's energy
sector, and the Ukrainian economy writ large, however, would
continue to be burdened by inefficiencies and cross
subsidies. Over time, if Ukraine followed through with
commitments to increase prices 20 percent per quarter until
equal to the price Naftohaz pays for gas, the price increase
would bolster Naftohaz's financial health. Without reform in
the sector, doubts as to Ukraine's reliability as a transit
partner will grow, and Russia and Europe will be even more
motivated to complete routes around Ukraine, leaving Ukraine
with the already accumulated IFI debt and diminished
prospects for paying it back. End comment.
PETTIT