- The Washington Times - Saturday, January 7, 2006

The compromise reached Jan. 4, abruptly raising Russian gas prices to Ukraine from $50 to $230 per 1,000 cubic meters is nevertheless a victory for common sense.

In fact, Ukraine will switch to Turkmenistan as its principal gas supplier and buy gas from Kazakhstan and Uzbekistan as well for about $95 per 1,000 cubic meters for five years — less than half the Western European gas price. Ukraine will still buy Russian gas, but much less than before.

By more than quadrupling the price, Moscow tried to deal a decisive blow to President Victor Yushchenko, whom Russian leaders perceive as pro-American and anti-Russian, and to influence the outcome of Ukraine’s March parliamentary elections. Ukraine will pay a heavy price: between 5 and 10 percent of its gross domestic product (GDP) will go to cover the new energy costs, and its economic growth in 2006 and beyond is likely to stagnate.

The attack may also have been a misstep: Russia’s willingness to excessively politicize its energy supplies damaged the its image as a reliable energy producer. Tens of billions of dollars in future foreign investments and contracts may be now at risk — much more than the value of Ukraine’s gas imports.

As a result of Moscow’s ill-considered move, Europeans are likely to turn to Turkmenistan, Azerbaijan, Algeria, Nigeria, Qatar and Iran to diversify their gas supplies. They will be wary of overdependence on Gazprom. Ironically, Russia, which just assumed chairmanship of the G-8, has proclaimed energy and energy security as a central focus of its term.

Ukraine is also to blame: It ignored the problem of subsidized gas and did not prepare for the inevitable price increase by improving energy efficiency and management. The price of Russian gas supplied to Ukraine in 2004-2005 was less than a third what Europeans paid, and it was clear the gravy train would end after the Orange Revolution, which Russia decried.

Ukrainian leaders should have taken steps, such as creating a larger gas reserve, setting money aside to ease the transition to higher prices and signing contracts with other suppliers. But they did not. Instead, the Yushchenko administration found itself rudderless in economic policymaking and did not repair relations with Russia so Moscow would give Kiev a break, as in the past. Russia now accuses Ukraine of siphoning off gas set aside for sale in Europe, something Ukraine claims it has the right to do. Ukrainian companies and officials were also allegedly reselling subsidized gas to Europe at market prices.

The new arrangement further complicates matters, as it hands over all Ukrainian gas imports to a Swiss-based company, Ros-UkrEnergy, half of it belongs to Gazprom and half is managed by the Austrian Raifeissen bank for undisclosed shareholders. There are published allegations that RosUkrEnergy is nontransparent and even be tied to organized crime.

The U.S. is interested in political stability, transparency and economic growth in Ukraine and Central Europe. Washington has invested heavily in Mr. Yushchenko’s administration and would not want it to fail prior to the crucial March parliamentary election. Voters are likely to blame an already-unpopular Mr. Yushchenko for failing to keep gas prices low.

The U.S. has also high stakes in integrating Russia as a major energy supplier into the world economy — if at all possible in view of the state’s current energy power grab. Turning oil and gas into the tools of statecraft — just as the Organization of Petroleum Exporting Countries (OPEC) did in the 1970s — runs against Western interests. Furthermore, U.S. energy companies hope to expand their energy partnerships with Russia, including development of the giant Shtokman gas field in the Barents Sea and investment in new fields such as the three Sakhalin Island projects in the Pacific.

In light of these considerations, the Bush administration should support a gradual transition to market energy prices and better management for Ukrainian industry. This can be done only by making Ukrainian industry more energy-efficient and thus more competitive in a higher energy price environment. Such transition will save Ukrainian economy billions of dollars. U.S. Departments of Commerce and Energy and the private sector should work with the government of Ukraine to develop and carry out a three-year transition program to achieve Western energy consumption standards in the industry.

Washington should work with the Ukraine government on a medium- and long-term energy security plan to diversify energy sources for Ukraine in both oil and gas. This should include a plan to buy oil from Kazakhstan and Azerbaijan and gas from Turkmenistan and Azerbaijan, including building a trans-Caspian oil and gas pipelines.

The United States should clarify to Russia that its heavy-handed energy geopolitics will backfire. Moscow risks undermining its bid to be a major energy player in Europe and the world, hurting perspectives for joint ventures, investment and energy trade. The U.S. Department of Energy should explain this to its Russian counterparts while promising serious U.S. energy investment if Russia returns to privatization of its oil and gas companies and pipeline consortia.

The Bush administration should insist that Russia’s World Trade Organization accession negotiations include full separation of Gazprom’s production and transportation (pipeline) assets and that both Russian and Western private investors’ representatives on the Gazprom board of directors be fully involved in strategic decisionmaking. Such participation would mitigate abuse of Gazprom as a tool of foreign policy by politicians and the federal bureaucracy.

It is in the best interest of Russia, Europe and the U.S. to move to a gradual schedule of price increases, energy efficiency, good management and transparency in Ukrainian economy. It is equally in Russian and the U.S. interest for all parties involved to focus on energy economics that benefits both countries, while avoiding provocation and escalation.

Ariel Cohen is Heritage Foundation senior research fellow in Russian and Eurasian studies and international energy security.

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