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