Kremlin, Inc

On Tuesday, July 22nd, Gazprom’s head Alexei Miller made a surprise visit to Kyiv in order to hold gas sphere negotiations, meeting with Naftogaz’s head Oleg Dubina, Ukrainian PM Yulia Tymoshenko and later President Yushchenko.

As a result of the talks, Tymoshenko has announced that the two sides have agreed on a logical mechanism for determining next year’s gas prices for Ukraine.  The exact figure will have to wait until after deals have been reached by Gazprom with the Central Asian producers Uzbekistan, Kazakhstan and Turkmenistan, but she has said there will be a progressive transition to “market” prices without a shock to the system.

Incorporating the terms of Central Asian gas deals suggests that the price for Ukraine will once again be based on the cost of production, rather than derived from the market prices in other European countries.

Earlier I explained the differences in types of deals:

The way I see it, there are only two legitimate ways to determine the price of gas for Ukraine:

• Option A: Take the cost of the gas produced (whether in Russia or in Central Asia). Add the cost of transit.  Add the cost of taxes and customs.  Add a industry-standard profit margin (maybe $5-15 per thousand cubic meters).  You are then left with the price for gas at the Ukraine - Russia border.
• Option B: Take the cost of gas charged by Gazprom to other major European consumers like Germany and Itay.  (This price is developed using a formula based on the price of oil, the closest “substitute” to natural gas.)  Subtract transit costs for the difference in distance between these countries and Ukraine.  Average these various prices together to arrive at the “European” price for Ukraine. Let Gazprom worry about where they get the gas–whether from Russian wells or Central Asian–for the supplies, as should be done when negotiations are going through Gazprom.

The question becomes who–Ukraine or Russia–will capitalize on the profit margin between these two types of contracts.  If it’s the first option, Ukraine will continue to use the difference to “subsidize” its internal consumption.  If it’s the second, Gazprom will succeed in transitioning away from its history (in the former Soviet Union) of agreements based on the cost of production to deals based on how much the consumer is willing to pay for the product.  This is understandably lucrative for Gazprom, at least so long as oil prices remain high.

Despite these comments from Tymoshenko regarding the influence of the price for Central Asian gas, Miller is alleged to have suggested that the future price for Ukraine be determined by taking 75-80% of the price Poland pays for its gas — about $315 per thousand cubic meters, based on today’s price of $420 in Poland according to Kommersant. Given that the Polish prices are sure to rise next year as well, this formula could well push the Ukrainian price to the $400 figure that has been kicking around lately.

Such a price, at over 2X higher than the current $179.50 charged, would seem to represent a “shock to the system” that Tymoshenko has promised against.  It is also worth remembering that the 25-20% difference in price from Poland would also account for decreased transit costs associated with delivering gas to Ukraine, which could represent approximately 5-10% of the price.

Suggestions by Tymoshenko to remove RosUkrEnergo from the scheme were rebuffed by Miller, who said that the trader’s services were still needed as a financial intermediary between Gazprom and Naftogaz.  As evidence, he pointed to the $800 million debt Naftogaz has racked up to RUE for the second quarter of 2008.  Presumably, such an occurrence would not be allowable under direct sales between Gazprom and Naftogaz.

Tymoshenko promised to fully repay the debt by August 1st. A clean balance sheet may cause Gazprom to reconsider the necessity of RUE, but this is far from certain.

Miller went on to meet with Ukrainian President Viktor Yushchenko and Dubia that evening, but little is known of their discussion.

The general director of Gazprom Sales Ukraine, a 100% subsidiary of Gazprom with a license to sell 7.5 billion cubic meters (bcm) of gas per year to Ukrainian industrial consumers, gave an interview in today’s Kommersant touching on the topic of gas prices for Ukraine:

 Kommersant: Not long ago, the head of Gazprom Alexei Miller stated that the price of gas for Ukraine could rise to $400 per mcm.  Is this realistic?

General Director Anatoliy Podmyshalskiy: Growth is connected, of course, with oil becoming more expensive, as well as with the objective wishes of Central Asian countries to move towards market pricing.  The formation of the price of gas in Turkmenistan, Uzbekistan and Kazakhstan is happening now. As a providor of resources, we are certainly interested in reaching a result as quick as possible.  But it is too early to talk concretely.

K: PM Tymoshenko stated that she and her Russian colleague Vladimir Putin have agreed on a smooth transition to market prices.  Would you consider going from $179.50 to $400 such a transition?

AP: Let’s talk about the real status of the market that is forming in the Central Asian countries.  If the price of purchases significantly rises, then engineering such a smooth transition as Ukraine is hoping for will not be easy.

K: If Central Asian gas will cost $400, is it possible that Russian gas will turn out to be cheaper?

AP: I don’t think so.  Russian gas, as you understand, is delivered in large volumes to European countries.  And the pricing forumla that these countries use for purchasing the gas corresponds to the cost of oil and petroleum products.

Here again we see this division between contracts based on different castes of consumers.

One other factor never mentioned in the negotiations is the quality of the gas.  Purchases are always based on volume — so many billion cubic meters at a price of so many dollars per thousand cubic meters.  Other places in Europe (though not all) as well as the US sell natural gas based on British Thermal Units (BTUs), a measure of the actual energy content within the gas.  This helps differentiate between various qualities of gas, as determined by chemical makeup.

Oil is similarly differentiated, with sulfur content and other factors contributing the price of crude.

The in-place system relying strictly on volumes, however, means that Ukraine is stuck paying for gas regardless of its energy content.  The country lacks the technology to transition to a different measuring system, though, and the strong historical precedence — and likely, pressure from Gazprom — is a further hindrance.

This issues of the quality of gas imported from Russia / Central Asia was raised at the recent energy policy round table I organized, and seemed to resonate with many of the participants.   Including this topic in the negotiations may be may be too much to ask for, however, as Ukraine’s leadership struggles with the threat of economic shock and a cold population.

Also potentially complicating the matter, rumors suggest that the fate of the gas price variously depends on other highly political issues:

• The direction of the Odessa-Brody oil pipeline.
• The involvement of Gazprom in any Black Sea project.
• The lease for Russia’s Black Sea fleet in Sevastopol.
• And of course, the upcoming presidential elections in Ukraine…

I went to Fuel and Energy Minister Yuri Prodan’s Cabinet of Ministers “hot line” session yesterday afternoon and managed to ask him about the Ukrtatnafta conflict between calls from disgruntled Ukrainians.

He described the situation as “stably bad,” reiterating that crude deliveries to Kermenchug had been about halved and included local Ukrainian oil and shipments from Kirkuk, Iraq.  He said it that it obviously makes the most sense for the direct pipeline to begin operation again, but was pessimistic about the chances for this happening anytime soon.

When I asked about the “working group” to be formed with his Russian ministerial counterparts, he explained that the Ukrainian side had organized its delegation but that the Russians had yet to put forward theirs.  This is despite the suggestion for the working group coming from the Russians.  If they do come forward with a delegation, Prodan said that the Ukrainian side would be happy to discuss the issue with the Russians.

Prodan confirmed that the respective PMs had touched on the subject during recent talks, but that he expected more progress would be made through ministerial-level discussions before kicking the proposed resolution up to Tymoshenko and Putin. However, he pointed to Ukrtatnafta’s inability to hold its scheduled shareholders’ meetings as evidence that the top management of the company (both Ukrainian and Russian) were not ready or interested to reach a compromise.

The last shareholders’ meeting was scheduled for May 29th, but it “unfortunately” failed to take place due to a lack of a quorum, according to a representative from Ukrtatnafta’s corporate law office.  The representative said only Naftogaz’s representatives showed up, and according to him, they only make up 43% of shareholders.

Naftogaz’s key argument is that they hold over 60% of the shares, but this position is not supported by Ukrtatnafta’s shareholder registrar, a company controlled by Privat.  Ukraine’s Supreme Court has ruled that the 18% share package in question should not belong to the Tatar-aligned faction, but it does not explicity place ownership of the shares into Naftogaz’s hands.

This management and ownership standoff has made it more difficult for the government to get involved, Prodan explained.

Meanwhile, Prodan said that Tatneft’s international suit against Ukraine, alleging $1.1 billion in damages and lost income, is continuing in the form of communications between law firms and respective lawyers, but he did not seem too concerned about the issue.  Tatneft is being represented by Cleary, Gottlieb, Steen & Hamilton, an international firm that has been advising the Tatar oil company throughout the conflict.

I asked Prodan if Seagroup and Amruz (two other affected parties) had joined in the proceedings, but he didn’t answer.  Their inclusion would likely boost the amount of damages being sought in the suit.

There is talk that should Igor Kolomoisky (a key owner of Privat) succeed in pushing through his proposal for the Odessa-Brody pipeline, he could funnel some of the incoming Caspian crude to the Kremenchug refinery.  The addition of the high-quality oil would help boost Ukrtatnafta’s production levels and output.  However, by far the easiest and most economical route is the resumption of Tatar crude delivered directly via pipeline, a fact underscored by Prodan.

Last week Vanco Prykerchenska Ltd. began international arbitration proceedings in Stockholm over a dispute with the Ukrainian government as the two sides continue to spar over an oil and gas project off the Crimean coast.

On May 19th, Ukraine’s Cabinet of Ministers unilaterally withdrew from the landmark 30-year production sharing agreement (PSA) covering Black Sea hydrocarbon exploration and development that had been reached with Vanco in the fall of 2007.  This followed an April 25th move by the Ministry of Environmental Protection to annul the special subsoil license that had been granted to Vanco stemming from the PSA.

The government, led by PM Yulia Tymoshenko, has

• argued that Vanco lacks the resources to develop the reserves,
• criticized the tender process that let Vanco negotiate for the PSA,
• denounced the terms of the PSA as unfair,
• suggested the state oil and gas company Naftogaz lead the project,
• lambasted the financial partners (Rinat Akhmetov’s DTEK, Evgeniy Novitskiy’s Shadowlight Investments and the Austrian investment firm Integrum Technologies) Vanco pulled into the project
• warned that Gazprom is apt to gain control of the resources,
• intimated that RosUkrEnergo’s Dmitry Firtash is involved in the project,
• and insisted the 13,000 sq km land parcel be re-divided into smaller sections, in the belief that this will speed up development.

On May 12th, Vanco sent a formal letter to the Cabinet criticizing the government’s unwillingness to directly negotiate and its failure to abide by the terms of the PSA.  This communication laid to the groundwork to open arbitration proceedings, with the option to file a complaint at the Stockholm arbitration court opening 60 days following the receipt of this letter.  That time period expired Friday, July 11th.

Vanco had received a letter from First Deputy Minister of Justice Yevgeniy Korniychuk on July 5th, suggesting for an additional 60 days of negotiations. This led Vanco to delay filing the initial arbitration proceedings as they sought to clarify the intent and legitimacy of the communication.

Korniychuk’s letter was addressed to Vanco International Ltd (VIL), a fully-owned subsidiary of the Houston-based Vanco Energy.  However, the Black Sea project is being run by Vanco Prykerchenska Ltd (VPL), itself a subsidiary of VIL.  VIL is jointly controlled by Vanco and the investment partners in the project — DTEK, Shadowlight and Integrum — on a roughly parity basis.

The exact breakdown of VPL’s shareholding and the identity of the figure(s) behind Shadowlight have been two questions surrounding the project and giving some legitimacy to the government’s worries about “shenanigans” going on.  The PSA had initially been granted to VIL, but the rights and obligations of the agreement were immediately passed on to VPL.  Vanco has asserted that this is within its legal abilities, but Tymoshenko has said this amounts to corruption.

The makeup of VPL was apparently formed after the lengthy 18-month PSA negotiating process scared away initial investor JNR Eastern Investments, forcing Vanco to find replacement partners.  Akhmetov, the owner of DTEK, is a fierce political rival of Tymoshenko and a member of the Party of Regions with Viktor Yanukovich, who served as PM during the signing of the PSA.

This relationship has led to calls both of Akhmetov benefiting from his political position and Tymoshenko unduly punishing her political enemies.

Tymoshenko’s government has refused to accept the legitimacy of Vanco Prykerchenska, hence addressing the letter to Vanco International.  However, Vanco stresses that VPL is running the project, and all communication must go through this entity.  The failure to bridge this gap led Vanco to go ahead with the arbitration proceedings on Wednesday, July 16th.

Vanco has stated that it remains open to negotiations during the beginnings of the court proceedings.  The company does not really want this dispute to go all the way to an arbitration hearing.  However, it seems to believe it is in the right (as  other commentators–particularly those from parties other than Tymoshenko’s BYuT–have suggested…) and Vanco stands to win a significant amount of money from Ukraine should it emerge successfully.

Ukraine’s Naftogaz has been accumulating volumes of natural gas above levels stipulated in its contract with RosUkrEnergo (RUE), according to assertions by Russia’s Gazprom.  Since July 1st, Naftogaz allegedly siphoned off an extra 1 billion cubic meters (bcm) of gas that was meant for RUE’s Eastern European customers.  It is now keeping that gas in uderground storage.

Naftogaz, worried over talk that gas prices could jump from $179.50 per thousand cubic meters (mcm) to over $400 per mcm next year, was apparently hoping to stock up on gas now while the price is cheaper.

Upon noticing the discrepancy, Gazprom last week demanded that Naftogaz revert to taking volumes as stipulated by the March gas sphere contract, which had Ukraine receiving 49.8 bcm from RUE parceled out for the rest of the year.  Naftogaz has now apparently resumed normal levels of gas deliveries.

However, these “unscheduled” additions to Naftogaz’s gas supply in storage have also added to the company’s substantial debt column–Naftogaz now allegedly owes RosUkrEnergo about $2 billion, a combination of long-term debts from previous years as well as outstanding accounts for the delivery of Russian gas during the first quarter of 2008 and Central Asian gas during the second quarter.

Naftogaz’s debts to the gas middlemen–whether RosUkrEnergo, UkrGazEnergo or even Gazprom’s subsidiary Gazprom Export itself–have long been a contentious topic.  This latest spat concerning taking unauthorized volumes (and the associated bill that will arise) only contributed to the areas of conflict between these actors.

This issue also helped foil a shareholders meeting for UkrGazEnergo on Friday.  RosUkrEnergo, 50/50 owners with Naftogaz, failed to show up citing frustration with Naftogaz’s unwillingness to address the growing debt issue.  UGE’s executive director Dmiry Glebko asserts that Naftogaz owes the trader $300 million from sales since the beginning of the year.  According to UGE, Naftogaz changed the date for the meeting seven times and also failed to provide some of the necessary paperwork for the conduction of the meeting.

Naftogaz dismisses these claims and blames RosUkrEnergo for sabotaging the meeting.  It is more worried about the distribution of UGE’s 2006-7 dividends, with Naftogaz expecting to receive about $170 million.

UGE counters by saying that it is unreasonable to discuss profit division while such outstanding debt remains.  I touched on this issue before, citing it as the reason that the last attempted shareholders meeting (on April Fools Day…) failed to convene:

Naftogaz apparently owed UkrGazEnergo $270 million for past gas payments.  Total dividends for the UkrGazEnergo ran at around $350 million, according to what I have heard.  Naftogaz approached UGE and suggested that instead of paying its bill for gas, it would just not collect its share (50%) of the dividends.  RosUkrEnergo, UGE’s other shareholder, objected to this idea, pointing out that $175 million does not equal $270, and consequently boycotted the shareholders meeting.

Ukraine’s Fuel and Energy Minister Yuri Prodan is giving a briefing tomorrow afternoon where he may address this conflict and other gas sphere issues.  It looks like I will be able to attend (though it’s far from certain with these types of things).  We’ll see what he has to say…

Yesterday Ukraine’s Cabinet of Ministers named the composition for Naftogaz’s new advisory board, the head of which will be Deputy Minister for Fuel and Energy Oleg Bugaev.  Like Naftogaz’s CEO Oleg Dubina, Bugaev has close ties to the powerful industrial-financial group Industrial Union of Donbas (IUD).  One of IUD’s co-owners, Vitaliy Gaiduk, is PM Yulia Tymoshenko’s close advisor and it is widely believed that IUD helps sponsor her political machine.

The advisory board had not met for the past three years, with its monitoring and guiding role being de facto filled by the Cabinet of Ministers.  The appointment of Bugaev to the top position on the board solidifies the position of IUD in the running of Naftogaz, as this is apparently the first time both key positions have been filled by figures connected to the same business group.

From 2003-2006 Bugaev worked at the state-owned electricity exporter Ukrinterenergo, where he was eventually appointed to lead the company by Gaiduk, who at that time was the vice premier in charge of the fuel and energy sector.  During that time period, Ukrinterenergo undertook regional export schemes that benefited IUD-connected enterprises.

(Ukrinterenergo is undergoing a bit of a shakeup–and leadership struggle–while attempting to switch from this old scandal-ridden system of quotas to a bid-based arrangement. Changes have included moving Ukrinterenergo do direct control of the Fuel and Energy Ministry as opposed to the state-owned Electricity Company of Ukraine.  Later, a figure closely connected to Rada Speaker Arseniy Yatsenyuk was appointment to lead Ukrinterenergo in a move seen as an attempt to balance competing influence from the Bugaev / Gaiduk side.)

After being fired in 2006 by Gaiduk’s rival Ivan Plachkov, Bugaev spent the next two years fighting a wrongful-dismissal suit before being appointed to his current deputy minister position in January of this year allegedly at the behest of Gaiduk.  He has no experience in the oil and gas sphere.

In May I met with a representative from Ukrgazenergo to discuss Ukraine’s gas sector.  When I asked him about hesitation among major industrial groups to sign gas supply deals with Naftogaz, he said that one of the key reasons companies were balking–besides facing higher prices–was worry over falling to the behest of an IUD-controlled (that is, a rival-controlled) Naftogaz.

For instance, he cited an arrangement between IUD and the Rinat Akhmetov-owned System Capital Management (SCM) where IUD’s steel factories barter gas supplies in return for iron ore from SCM. (Up until recently, IUD had direct deals with Uzbekistan for supplementary gas deliveries outside of what is delivered to Ukraine by RosUkrEnergo.) Adding the resources of Naftogaz, particularly the distribution pipeline system, to IUD’s side would clearly tip the scales in such deals towards Gaiduk.

The other notable inclusion in Naftogaz’s board makeup is Alexander Shlapak from the President’s secretariat who was apparently added to the list at the last minute.  The board’s composition is typically dictated by the Cabinet of Ministers, suggesting that the inclusion of a key figure from President Yushchenko’s administration is a compromise, possibly for allowing Bugaev to take the leadership position.

Theoretically the board members are supposed to be chosen based on the activities of Naftogaz’s various subsidiaries.  But when political maneuvering is in play, this idea tends to fade away…

Writeup from last month’s energy forum that I organized.  Hopefully I’ll get out a more in-depth report soon.

The obstacles facing Ukraine’s energy sphere are significant but not insurmountable, according to a panel of international experts speaking at a forum on the role of government policy within Ukraine’s energy sector.

The June 17th event, entitled “Energy Policy in Ukraine: Challenges, Opportunities and the Future,” was attended by a mix of industry experts, young professionals and interested students.  The forum was organized by the Fulbright Program in Ukraine, the Ukrainian Center for Independent Political Research (UCIPR) and the Forum of Young Leaders of Ukraine.

“One theme that emerged during the conversation,” according to Hans Stege, a Fulbright Research Fellow who moderated the event, “is the role of government policy in encouraging investment in Ukraine’s energy sector.”

He cited a presentation by Maxim Vityk, an exploration geologist and the new business development manager for Shell in Ukraine, which called for legislative stability as one way to improve the country’s investment attractiveness.

Shell is “concerned at the gas marketing limitations and the price regulation introduced with every annual budget law,” says Vityk. “Conditions on exploration and development licenses change with every budget cycle.” He emphasized that “this is not a stable platform that encourages investment.”

Julia Yatsenko, a representative from the major agricultural firm Nafcom-Agro, brought up the government’s monopoly on grain spirit production as a factor hampering any large-scale investment in ethanol capabilities.  The government could help stimulate the ethanol industry, a potential domestic substitute for foreign oil imports, through incentives such as tax breaks.

“Draft laws to support the production of biofuels through these or other means have been introduced in Parliament by all major political forces,” says Yatsenko.  However, she adds that “adopting such a law, just like abolishing the state monopoly on the production of ethanol, depends on overcoming the current parliamentary crisis.”

Another major topic of the forum centered on Ukraine’s status as an energy mediator between the Russian and Caspian producing regions and the European market.

The participants agreed that Ukraine sits in a good position to capitalize on energy transit projects like those explored during last month’s Energy Security Summit in Kyiv.  However, the government needs to focus on infrastructure investment and regional cooperation in order to protect its current key position as a transit point.

“Ukraine’s gas transportation system needs investment and refurbishment,” says Anatoliy Baronin, general director of the analytic group Da Vinci AG.  However, “the budget of Ukraine and the state of Naftogaz Ukrainy does not allow for discussion on self-sufficiently covering these expenditures.”

The EU and Ukraine are in talks over $2.5 billion in aid to cover infrastructure reconstruction costs, but according to Alexander Todiychuk, president of the Kyiv International Energy Club “Q-Club” and former head of Ukrtansnafta, progress “has been slowed by Ukrainian officials.”

Todiychuk, who is also the coordinator for the fulfillment of the Memorandum of Understanding Concerning Energy Cooperation between Ukraine and the EU which would cover this aid package, explained that “the financing process is too transparent and does not allow opportunities for abuse, a fact that certain leadership within the industry does not like.”

Despite this transparency, Baronin cites looming elections and corresponding “unstable political conditions” in predicting that “a large part of this money will not be used for its stated goal.”

The need to maintain Ukraine’s current transport capabilities through adequate investment is even more pertinent when considering the various bypass projects now being considered.

Based on a combination of such projects as the North Stream, South Stream and Nabucco pipelines, Ukraine may see its natural gas transit volumes drop by 60-70% by 2025, according to Baronin.  The corresponding drop in revenue would cripple any investment attempts by that time.

However, as UCIPR analyst Vitaliy Martyniuk points out, rising demand from Europe and increased Russian deliveries may keep Ukraine’s transit system in use.  This is especially true given that the bypass projects, still largely in development stages, are likely to be delayed further.

“The EU views—and will continue to view—Ukraine as an import energy transit country for transporting Russian and Central Asian gas to Europe,” says Martyniuk.  He expects that this relationship will continue the interdependence between Russia’s gas supply resources and Ukraine’s gas transit capabilities.

Meanwhile, brokering European access to the Caspian region could further strengthen Ukraine’s position, according to Tetiana Temnyuk, Secretary of the Young Diplomats Club of Ukraine. “Without a doubt, a key position in transiting Caspian resources would give Ukraine an exclusive priority and would bring the country closer the stated strategy of Euro-Atlantic integration,” she says.

“Nevertheless,” Temnyuk adds, “Ukraine may have already lost this fight, considering the growing role of alternatives to the Ukrainian route for the diversification of energy supplies.”  She cites pipeline projects supported by Turkey and Romania as potential competition for Ukrainian proposals, which center on the Odessa-Brody pipeline.

“The appearance of new pipeline routes that cut across the Black Sea region to European countries can change the pipeline architecture of this part of the world,” says Temnyuk.

Building on the idea of a changing landscape, many of the forum’s participants touched upon the potential of the Odessa-Brody pipeline to play a large role in determining Ukraine’s future transit status.

Besides helping Caspian crude reach the European market, running Odessa-Brody south to north could also help reduce Ukrainian dependence on Russian oil supplies.  “An over-dependence on Russian [oil] is problematic,” according to Andrew Matheny, a former Fulbright Research Fellow in Ukraine and an analyst at the global energy consulting firm PFC Energy.  Ukraine’s “crude sourcing could be more diversified” by using Caspian supplies, but he cites supply and profitability worries as obstacles to moving forward with the project.

Matheny also doubted the practicality of a potential new refinery for Ukraine, despite recent proposals. Existing Ukrainian refineries ran at only 26% of their capacity in 2007, he says, and bridging the gap in quality between European and Ukrainian petroleum products would be better served by upgrading existing infrastructure rather than undertaking new projects.

Todiychuk, the president of Q-Club, takes a similarly dim view of the prospects for a new refinery located near the Yuzhniy oil terminal, but he believes that a technologically advanced refinery could be built near Brody.  A modern refinery in that location could “fill the Ukrainian market with high-quality products and stimulate other factories into reconstruction and modernization,” he says.

Support from the government, particularly in enforcing higher fuel quality regulations, would make the project more attractive to investors.

In such instances, the involvement of politics can be beneficial to the energy sphere.  Whether in stimulating biofuel production, stabilizing the domestic oil and gas legislation or ensuring the gas transport system receives much-needed investment, Ukraine’s government can help support the development of the country’s energy sector while aiding the country’s quest for greater energy security.  As Matheny summed up, “much of the industry’s outlook depends on government policy and domestic legislation.”

Naftogaz’s chairman Oleg Dubina gave an interview to Alla Yeremenko in last week’s “Mirror Weekly.” (Russian version) Below, find my annotated version of it:

- Mirror Weekly: Oleh Viktorovych, is it true that Ukraine and Russia agreed on a gradual rise in price on gas for Ukraine as it was announced after the recent talks between Tymoshenko and Putin? Does this mean that a two-fold increase in price of gas or increase up to USD 400 for 1000 cubic meters of gas is not a real possibility today?

- Oleg Dubina: As I said earlier, Naftogaz Ukrainy and Gazprom have created two expert groups to prepare issues for the future talks. I am only aware of the fact that both sides are disposed to introducing a gradual increase in price of gas for Ukraine.

- MW: Did you discuss with the representatives of Gazprom the terms of the contract between Naftogaz and Gazprom? Will Ukraine and NJSC Naftogaz in particular be a third party in the negotiations between Gazprom and the Central Asian countries?

- OD: No, we didn’t discuss the terms of the contract for the next year yet. NJSC Naftogaz will start negotiations about the terms for next year after we receive the necessary directives from the government. If the decision on transformation of the negotiations from the level of enterprises to the inter-governmental level is made, the Energy and Fuel Ministry will receive the directives and will conduct the talks.

Last year’s negotiations were held almost entirely at the Ministerial level, with Ukraine’s delegation led by former Fuel and Energy Minister Yuri Boyko.  Since the new Tymoshenko-led government has come in, the role of Naftogaz’s leadership in the negotiations–that is, the role of Dubina–has increased.

- MW: Is it possible that you will receive the directives from both the Cabinet of Ministers and the Secretariat of the President?

- OD: I think that the directives will be coherent.

Last year’s negotiations saw Yushchenko deliver directives to Boyko, a member of former PM Viktor Yanukovich’s Party of Regions.  He apparently followed the presidential instructions, but likely was influenced by his party leadership as well.  Boyko was (and still is) a well connected figure in the energy spheres of both Ukraine and Russia.

- MW: When do you expect them?

- OD: On the next week.

- MW: Is it possible that we will sign the contract with Gazprom in January, as usual?

- OD: It would be more correct to resolve this matter in September.

This alludes to the seemingly standard process of waiting to the last minute, or even going beyond deadlines, in signing key agreements.  Last year’s original deal was reached in December, after beginning serious negotiations in October or so.  However, disagreements pushed a more final agreement to March.  Earlier statements had the Ukrainian side expecting a deal by this fall.

- MW: What might be the formula for defining the price of gas for Ukraine in 2009?

- OD: This question is being studied by the expert groups. The final formula will be defined during the negotiations.

The way I see it, there are only two legitimate ways to determine the price of gas for Ukraine:

• Option A: Take the cost of the gas produced (whether in Russia or in Central Asia). Add the cost of transit.  Add the cost of taxes and customs.  Add a industry-standard profit margin (maybe $5-15 per thousand cubic meters).  You are then left with the price for gas at the Ukraine - Russia border.
• Option B: Take the cost of gas charged by Gazprom to other major European consumers like Germany and Itay.  (This price is developed using a formula based on the price of oil, the closest “substitute” to natural gas.)  Subtract transit costs for the difference in distance between these countries and Ukraine.  Average these various prices together to arrive at the “European” price for Ukraine. Let Gazprom worry about where they get the gas–whether from Russian wells or Central Asian–for the supplies, as should be done when negotiations are going through Gazprom.

The question becomes who–Ukraine or Russia–will capitalize on the profit margin between these two types of contracts.  If it’s the first option, Ukraine will continue to use the difference to “subsidize” its internal consumption.  If it’s the second, Gazprom will succeed in transitioning away from its history (in the former Soviet Union) of agreements based on the cost of production to deals based on how much the consumer is willing to pay for the product.  This is understandably lucrative for Gazprom, at least so long as oil prices remain high.

- MW: Will the transit tariff for pumping Russian gas through Ukraine be increased?

- OD: If the price of gas is changed, then the transit tariff will be changed too.

Since Ukraine uses large amounts of gas to power the turbines that propel the supplies through the pipeline system, the external gas price should be the largest factor in determining transit costs, particularly when–as is the case with Ukraine–the transit infrastructure is old and capital costs are no longer factored into the equation.  Unfortunately, in the last few negotiating sessions, Ukraine has failed to press this issue strongly enough.  In my opinion, transit costs should realistically be between $2.50 and $3.00, as opposed to the current $1.70.

- MW: But in this case, the Russians promise to increase the transit tariff for transportation of Central Asian gas to Ukraine…

- OD: Let’s consider that Ukraine buys Central Asian gas at the border between Russia and Ukraine…

This is only logical, as Russia’s gas system is set up the same as Ukraine’s.

- MW: Will Ukraine try to ensure that all Russian gas exported to Europe is sold at the Eastern border of Ukraine and that Ukraine is negotiating with the buyers of Russian gas regarding the transit tariff?

- OD: I think that this would be a political decision.

- MW: Are our European partners, in your opinion, ready for such a decision?

- OD: As a transit transporter of gas, we are unnoticeable for Europe since Gazprom is accountable for all gas supplies to Europe, and the fact that Naftogaz is transporting this gas through Ukraine in not mentioned in any of the agreements or contracts. Gazprom sells gas to European customers and the price of gas for them includes the costs of transit.

Indeed, Gazprom’s contracts with European customers clearly state that the Russian company is in charge of ensuring that the gas gets safely delivered to the customer.  This really only became an issue with the breakup of the Soviet Union, as Gazprom (that is, its predecessor) inherited contracts stipulating its responsibility in delivering gas to the “Iron Curtain.” This forced the company to make deals with the respective countries along the way, none of whom were prepared to become any more than passive intermediaries in the process.

Theoretically, Ukraine could benefit by taking over Russian supplies meant for Europe at the border of the country–that is, buy all Russian gas heading westward, and negotiate its own contracts with the consuming countries.  Practically, none of the consumers would want this, as Ukraine has yet to prove itself capable of this responsibility.

You can lament the problems of Gazprom all you want, but it has been incredibly successful throughout its history at getting the right amounts of gas to the right foreign customers.  The only exceptions to this are politically-motivated shutoffs to the Baltic States soon after the breakup of the USSR and the Jan 1st, 2006 fiasco with Ukraine.

- MW: Is it necessary for Ukraine, in your opinion, to join the negotiations on gas supplies between Russia and the Central Asian countries?

- OD: On the one hand, there is no point in this as we have already lost the contracts with Turkmenistan and with Uzbekistan. However, on the other hand, if we don’t try to resume the relations with the Central Asian countries, we will be doomed to be dependent on Gazprom.

Dubina has been working since he became chairman at re-starting a relationship with the Central Asian producers, so far unsuccessfully.  He principaly faces competition from Russia and China.

- MW: According to ZN sources, the Ministry of Foreign Affairs of Ukraine requested that Naftogaz Oleksiy Ivchenko be named ambassador of Ukraine to Turkmenistan. Will this help to solve the problems?

- OD: Considering that we don’t have any relations with Turkmenistan in gas sphere, if Mr. Ivchenko helps to conclude a direct contract on gas supplies with Turkmenistan (what he didn’t manage to do in 2005), we will be very grateful to him.

…

- MW: What are the liabilities of the Ukrainian consumers of gas to NJSC Naftogaz?

- OD: Municipal energy enterprises are our main debtors. They owe us around UAH 1.8 billion and the residents owe us UAH 153 million. Liabilities of industrial enterprises are around UAH 450 million totally. The biggest debtors among the industrial enterprises are OJSC Rivneazot – UAH 119.9 million, Dneproazot – UAH 153 million, Crimean soda plant – UAH 50 million, Crimean Titanium – UAH 30 million. And the debts of these enterprises appeared in April-May, 2008.

If these consumers sound familiar, it’s because they are the same ones who were protesting the loudest when control of the gas sales was switched from UkrGazEnergo to Naftogaz’s Gaz Ukrainy. Last I heard, they were being supplied by UkrGazEnergo, which has enough gas in storage to supply their few remaining customers for another few months.

…

- MW: Russian Prime Minister Vladimir Putin mentioned the debts of Ukraine to Gazprom during the recent meeting with Yuliya Tymoshenko. What are these debts?

- OD: NJSC Naftogaz doesn’t have any debts to Gazprom for 2008. Those USD 2 billion that the Russian prime minister mentioned, form the debt of the companies UkrGaz-Energo and RosUkrEnergo to Gazprom for 2007.

…

- MW: Actually, Naftogaz was created to accumulate resources and cash flows, a considerable part of which was spent for different personal and political needs of the leaders of the country. Is there a possibility to rid the company of dirty and shady schemes? Are the Security Service of Ukraine and the General Prosecutor’s Office able to contribute in this process?

- OD: At the time being, there is the possibility to clean up our company. Furthermore, during last six months, we were successfully doing this with the help of the government. During this time, we were able to pay a considerable part of our debts and resolve the problem with payments from UkrGaz-Energo. It is possible to move further with cleaning now. However, one should understand that we need money in order to clean everything in our company. And we have a lot of losses because of unsatisfactory work of the subsidiaries which we don’t know how to cover. This is not right.

…

- MW: The General Prosecutor’s Office claimed that Naftogaz is not paying customs duties for gas supplied to Ukraine in the first quarter of 2008. It has even instituted criminal proceedings…

- OD: The General Prosecutor’s Office instituted a criminal case and transferred it to the Security Service of Ukraine. I would like to note that Naftogaz is not able today to pay this customs duty since there are no acceptance reports on this gas or those reports that are there do not comply with existing commercial law, and I don’t have the right to sign them.

I have also heard (from other sources) that Naftogaz has failed to pay its import duties on the gas.

- MW: Does Naftogaz possess any legal means to organize shareholders’ meetings at those open joint stock companies in which the state share is considerable – Ukrnafta and UkrGaz-Energo?

- OD: No, and we won’t have such possibility until the law on open joint stock companies is amended.

- MW: In other words, the situation with dividends that Ukrnafta and UkrGaz-Energo should pay to Naftogaz is not clear. What are the losses of Naftogaz from this?

- OD: The losses are huge. The dividends that Ukrnafta should pay for 2006-2007 are more than UAH 2 billion. And the dividends that UkrGaz-Energo is supposed to pay for 2007 are USD 150 million.

Naftogaz apparently owed UkrGazEnergo $270 million for past gas payments.  Total dividends for the UkrGazEnergo ran at around $350 million, according to what I have heard.  Naftogaz approached UGE and suggested that instead of paying its bill for gas, it would just not collect its share (50%) of the dividends.  RosUkrEnergo, UGE’s other shareholder, objected to this idea, pointing out that $175 million does not equal $270, and consequently boycotted the shareholders meeting.

- MW: What is your opinion on the conflict with Prykerch oil and gas bearing territory? Naftogaz also intended to get a part of it…

- OD: I think that this topic is overly politicized. The problem is that nowhere in the world such a huge territory (around 13 thousand square kilometers) is allotted to one company. In my opinion, the situation is as follows: we sold too large a plot to a speculator. If we divided that plot into 12-15 sections and put them up for sale by tender, we would have already had results. At present, two years after this big plot was allotted to that small company, no works in the Prykerch oil and gas bearing territory have been started.

This Black Sea region is unique, in that it is essentially virgin territory.  It is attractive because it has similar geological properties to the hydrocarbon-bearing Caspian Sea.  However, the depths are significantly deeper, and no one has drilled a well to actually see if there is anything down there. In established shelfs, small plots are fine because a few number of wells can be profitable.  When the risks increase, both in terms of the unknown factor and the depth involved, then larger plots need to be offered to increase the potential payout.

The claim that production would already have started is extremely hard to believe.  Getting a ship capable of drilling the depths needed into the Black Sea is a difficult task, made tougher by a global surge in demand for deep-sea rigs.  The need need for 3D seismic testing also pushes the timeline out further.  And let’s not forget, the government certainly took its time during the year and half PSA negotiating period.

- MW: What is your proposal concerning Ukrainian part of the Black Sea shelf?

- OD: I would propose to conclude an agreement on joint development of the Black Sea shelf on the territories of Ukraine and Russia between Ukraine and Gazprom. We would work with them on their territory and they would work with us on our territory.

- MW: What company from the Ukrainian side should be a party to this agreement – Chernomorneftegaz?

- OD: No, only NJSC Naftogaz Ukrainy should be a party to this agreement.

- MW: Why do you propose to conclude an agreement on the development of the Black Sea shelf with Gazprom?- OD: The Russians are interested in oil. We are ready to develop Ukrainian fields in the shelf together with the Russians and give them all oil in exchange for all gas. We don’t need oil today since we don’t have any oil-processing enterprises and we have very high duties to export it. In our case, it wouldn’t be a business. That’s why I talk about gas today. We could conclude a production sharing agreement so that Gazprom would take away oil and we would take away gas.

And those joint ventures created between Chernomorneftegaz and Canadian company Shelton Canada Corp. and British CBM Oil don’t bring any results. Today, we are going to abrogate the contracts on joint development of the shelf with those companies. They don’t want to sell gas to the residents of Ukraine because the price of gas for the residents is USD 50 when the price of gas for the industrial consumers is USD 300…

I think it’s rather ironic that Tymoshenko used the threat of Gazprom involvement in the Black Sea project as a major rallying cry against the Vanco PSA, while now Dubina is suggesting that cooperation may be ideal.  Neither Gazprom nor Naftogaz have any deep-water experience, so it’s unclear how such a partnership will work out, or if it would speed up the timeline for production at all.  The gas / oil split is interesting, but again, until wells are dug, it is difficult to know what amounts of which hydrocarbon are present.  Anyway, I’m hoping to write an update on the Vanco situation over the next couple days, so will touch on this again.

Update (7/14/08): Added bit at the end regarding getting back in contact with the energy arm of Basic Element (En+), but I’m still awaiting an official response…

—

When it surfaced that a mysterious Austrian investment firm called Integrum Technologies was involved in the controversial Vanco Black Sea offshore project, many commentators became worried that some unknown force could influence Ukraine’s hydrocarbon development prospectus.  Indeed, not knowing who is behind a major player in this theoretically massively expensive–and lucrative–project has raised much doubt over the legitimacy of the deal.

Based on the information given at the press conference, Intgrum is the anonymous subsidiary of a larger Austrian investment firm that was created for the purpose of investing into projects within Eastern Europe and countries of the former Soviet Union.  The main investments of Integrum include the real estate, banking and energy sector ventures.  The company invested over $100 million in 2007, but refused to give the exact figure.  It was represented by Gerhard Eckert at the press conference, who was listed as the head of Integrum’s supervisory board.

There isn’t much to work with for the lay observer.  A Google search of the term leads to some results touting a web design company, before getting into coverage of the Vanco deal.  But nothing revealing about the investment firm.

The Austrian connection immediately drew suggestions that Integrum could be connected to OMV, that country’s “biggest listed industrial company” and “Central Europe’s leading oil and gas corporation.”

I sent the following email to an OMV representative from their press office (listed on their website) at 11:53 AM (Kyiv time) on Friday, May 16:

Hello Mr. [redacted],

I am an American Fulbright research in Ukraine studying energy and political issues.  I was hoping to receive a comment from OMV about speculation that the company is connected to Integrum Technologies Ltd., which was recently announced as a investment partner in the Black Sea offshore oil and gas project being led by Vanco. Does this represent an investment in Ukraine’s hydrocarbon sphere by OMV?  Or are suggestions that Integrum is linked to OMV unfounded? Can you explain this relationship at all?

Thank you very much,

Hans Stege

At 2:11 PM that day, I received the following:

Dear Mr Stege,

There is no connection between OMV and Integrum Technologies Ltd. at all.

Kind regards from Vienna,

Christa [redacted]

Press Officer
Corporate Communications
& Public Affairs

OMV Aktiengesellschaft
Otto-Wagner-Platz 5
A-1090 Wien / Vienna
Austria

This was a refreshing bit of straightforward and simple responsiveness, particularly after dealing with months of interactions with tight-lipped (and sometimes outright rude) Ukrainian businesses and government agencies.  However, it didn’t answer the question of who was actually behind Integrum.

Discussions with a colleague brought up the idea that Integrum could be connected to Oleg Deripaska, the Russian metals magnate worth $28 billion.

Deripaska had recently made moves into the regional energy sector by seeking to buy the Russian oil company Russneft in a deal steeped with political overtones.

Deripaska is also connected to Nathaniel Rothschild, who was previously slated as the financial backer for Vanco until the protracted PSA negotiating process allegedly pushed him out of the picture.  Rothschild was a key broker in the deal that combined Deripaska’s aluninum company Rusal with his rival Russian firm Sual and assets controlled by the Swiss commodities trader Glencore to create the world’s largest aluminum conglomerate.

Basic Element, Deripaska’s vast holding company, also includes a presence in Austria based on a 25% stake in the construction firm Straberg.

I sent the following email to Basic Element’s publically listed generic information email address — the only one I could find — at 3:16 PM on June 23rd:

Hello,

I am an American Fulbright researcher in Kyiv studying regional energy and political issues.  I am wondering if Basic Element could comment about rumors suggesting that the company or one of its subsidiaries may be linked to the Austrian investment firm Integrum Technologies, which was recently announced to be involved in the Vanco-led Black Sea offshore hydrocarbon project.

Thank you,

Hans Stege

After failing to receive an answer (and getting caught up in other matters), I called them up yesterday to try to get a response.

I started with Basic Element’s Austria contact, given the nature of my question.

Woman: Allo?

Me [taken a bit aback that a representative to such a company would answer so simply and abruptly]: Uh, yes, I was wondering if I could talk to your press department.

Woman: I’m sorry?  Could you speak more slowly yes?

Eventually, after switching into Russian, I managed to explain to her what I was interested in.  She responded by saying that the Austrian office was in fact still in construction and wouldn’t be finished until this fall.  She was apparently just part of the “advance” team, and couldn’t answer my question.  She suggested I call Moscow.

So call Moscow I did.

I attempted to explain what I wanted to the head receptionist, who passed me along to the press office.  There, they passed me along to the energy sector office, who passed me on to another woman, who passed me on to another woman–which turned out to be the first receptionist I had talked to.

Me, launching into the fifth rendition of my introductory remarks (everything from here and below is translated from Russian): Hello, my name is Hans Stege, I’m a Fulbright researcher in Ukraine…

Woman: Yeah, I already passed you to the press office.  They didn’t answer?  Or what did they say?

Me: Oh.  Well, they passed me to someone else, who passed me to someone else.

Woman: Well…sigh…you know, there’s a Kyiv office.  You should try there.  Here’s the number…

I called the Kyiv office, happy to save money on long distance.

Woman: Allo?

Me (by now nonplussed by this greeting): Hello, I’m an American Fulbright researcher in Kyiv studying energy issues — could I talk to the press office?

Woman: Why?

Me: I’m interested in the relationship between Basic Element and the Austrian investment firm Integrum Technologies.  The Moscow office suggested I contact you.

Woman: I’m sorry, but I need the name of someone in particular before I can transfer you.  You need to call back Moscow and get the exact name of someone in this office.

At this point I took a lunch break.

I called back the Moscow office and get reconnected to the press service.  They suggested I send them an email, and proceed to painstaking spell out “info@basel.ru” — the generic address listed on their website that I tried weeks ago.  When I explained this to them, they mentioned that they get “thousands” of emails per day, that there’s no possible way they can read them all.  It’s better to send an email and then call them back so they’ll be sure to see it.

I resent my June 23rd email above, and called them back five minutes later.  After being reconnected to the press office (though to a different woman), I waited as she sifted through the in-box and finds my email.

Woman: Ok, I see it — from “Hans Stedzh,” yes? [My last name is pronounced “stehggee,” rhymes with Peggie.]

Me: Yeah, that’s it…  So, do you think I can get an answer?

Woman: Hmm… I’ll transfer you.

So started another cycle.  I once again got transferred to the energy sector, and then to the press office within the energy sector, and then on hold for five minutes, then to another woman, who sends me back to the energy sector.  I went through my spiel again, the woman sighed, and said “wait a minute,” and transfers me again.

The next woman’s “allo” is broken up by static, and we spent the better part of a minute asking each other if we’re audible.

Eventually…

Me: I…sigh…My name is Hans Stege, I’m a Fulbright researcher in Ukraine.

Woman: Ok.

Me: I’m was just talking to someone in the press service, and then someone in the energy sector — is this also the energy sector?

Woman: Yeah… we’re in the energy sector…

Me: Is this the press service there?

Woman:…No, but I can give you the email of someone…What’s the issue you’re calling about?

Me: I’m wondering about the connection between Integrum Technologies and Basic Element.

Woman: Hold on..[puts me on hold]…Ok, I’ll give you an email, because no one is hear to answer your question.

Me, sensing a refrain: Well, I just sent an email to ‘info@basel.ru’…

Woman: You sent it to Basic Element?

Me: Yeah…

Woman: Because this isn’t Basic Element.  We’re a different company.

Me:…Um…what company?

Woman: M+ (’emplus’) Management.

Me: Uh huh… also in Moscow?

Woman: Yes.

Me: Uh huh…Um… I started by calling Basic Element, but they passed me along many times and I don’t know where I am right now.  But, what’s the email address I should use for you?

She wasn’t sure she could help anymore, saying that they couldn’t answer for Basic Element, as they’re “a completely different company.”  They work together, however, and this company is also in the energy sector, so I convinced her to pass along their email just in case.

I laboriously copied down the address, which ended in emplus.ru, and dutifully sent off a translated and slightly adjusted copy of my earlier email. [update — see below]

It immediately bounced back at me, with Gmail saying that “Delivery to the following recipient failed permanently.”

I attempted various variations to the address based on typical mishearings or mispronounciations.  The result was 9 different tries followed immediately by 9 different failures of delivery. (I’ve since added a few more unsuccessful attempts.)

I wasn’t necessarily expecting a straight answer from Basic Element, but I wasn’t expecting such problems.  And this was before I had even gotten to the meat of the questions — the people I were talking to were not the kind of people who might sweat over questions linking their company to a shadowy Austrian investment firm.  It was just an example in communication problems that I’ve seen plaguing many of the companies — small and large — in this part of the world.

Very likely, there were language issues involved.  But a company with $27 billion in assets last year should be able to work out a legitimate reception service to get people’s questions answered.

None of the woman were overtly mean or anything like that, but it was clear that my type of inquiry was unexpected and unwanted. However, for Deripaska to be considered more than just another resource-rich Russian — and for Russian companies to move above their stigma of uncooperativeness and secrecy — Basic Element might want to make getting an answer to a simple question a little bit easier.  Take a note from OMV’s response.  Simple and straight to the point is much more effective than obtuse and confusing.

Not making it easy to check up on information is also a good way for rumors to spread, particularly when the issue is so controversial as the Vanco situation.  Of course, having blog posts linking your name to the issue may contribute to speculation.  But we’ll see.

In the meantime, I’m still waiting for a response back from BasEl from my email…

Update (7/14/08): So “emplus” is actually En+, which makes much more sense.  Awaiting a response from someone there now.  Also of note, the phone numbers for the US Embassy in Moscow and Basic Element’s head office differ by only one digit, as I coincidentally found out today.

Below is a version of my introductory remarks for last week’s energy forum that I organized.  I’m planning on incorporating some of the other presentations into a future post and project outlining some of the major challenges and opportunities facing Ukraine’s energy policies.  Sorry for the poor image quality — feel free to download the complete PowerPoint presentation.

A few weeks ago, leaders from surrounding countries arrived in Kyiv to discuss “energy security.”  Like the two previous such summits, this event was an opportunity for CIS and former Eastern Bloc countries to coordinate attempts to escape over-reliance on Russian energy sources.  Much of the talk concentrated on ways to facilitate the transfer of oil and gas from the Caspian region on to Europe while bypassing Russia, which currently has a near-monopoly on access the Central Asian energy supplies.  Such projects are supported by the US and EU governments but have faced problems in their implementation.

As both Vitalii and Tetiyana will touch upon, these transport efforts have serious geo-political connotations that can complicate a strictly economic analysis.  At the same time, projects based solely on political motives will almost never succeed.  The energy sphere, as Alexander will emphasize, is still dominated by supply and demand.  Indeed, many commentators are questioning the profitability of the large refinery project announced during the course of the summit, especially, as Andrew will talk about later, with Ukraine’s current refining sphere in a state of flux.

Nonetheless, despite this uncertainty Ukraine is in an advantageous position to capitalize on the transit of energy resources.  It lies between two separate producing regions—Russia and the Caspian—and one of the world’s largest markets in Europe.  However, as Anatoliy will mention, Ukraine needs to ensure it adequately invests in its transit infrastructure in order to continue to benefit from this geographic advantage.

A further development to come from the summit was a joint declaration stating that “no country has the right to use energy as a political lever,” a clear reference to worries over Russia using its pipelines as foreign policy instruments.

Such accusations were particularly loud during the Ukraine-Russia gas dispute in the winter of 2005-6, which was punctuated by a brief decrease in gas pressure on January 1st.  These worries over an energy-rich Russia bullying its neighbors were subsequently crystallized by Vice President Dick Cheney’s “tools of intimidation and blackmail” quote two years ago.

This year’s pricing and supply conflict seemed to mark a step back from the political pressure rhetoric, with a US State Department spokesman labeling it a “legitimate commercial dispute” that should be “resolved in a commercial way.”  The European Union’s Energy Commissioner Andris Piebalgs echoed these statements in his own comments on the “bilateral commercial dispute.”

But while the international relations side of the conflict may have been somewhat diminished, the gas negotiations fueled significant domestic political repercussions.  The division that soon developed between Yushchenko and Tymoshenko over their respective visions of gas supply contracts was labeled by many commentators as the first fracture in a fragile coalition already destined to split.

Uncertainty over the future of the supply scheme likely contributed to insistence from Gazprom over the repayment of a virtually endless number of debts placed before the financially-strapped Naftogaz.  Meanwhile Gazprom, in the midst of international negotiations for its South Stream project, was happy to capitalize on this seeming weakness and general instability as evidence of the need for the bypass pipeline.

Even now, as Ukraine has succeeded in severely limiting the role of gas trader UkrGazEnergo within the supply scheme, a steady stream of debts—whether to Gazprom, RosUkrEnergo, or even the government’s customs service—has handicapped Naftogaz’s quest for a long-term gas deal and the potential stability that would entail.  The situation is further complicated by grumbling from major industrial consumers over prices higher than those charged by UkrGazEnergo—and that continue to rise—along with worry by some that the Industrial Union of Donbass may capitalize on its close relationship to Naftogaz to pressure competing financial-industrial groups.

In the meantime, Naftogaz continues to flirt with a default on its loans even as it is shopping around for a new round of credit.  The company is seeking the latest loan in order to repay Gazprom and stock the country’s underground storage reserves ahead of the winter heating season.

It is frustrating to realize that even in the age of $130-a-barrel crude, a national oil and gas company—particularly one with such potential for transit revenues—can have these financial difficulties.  Indeed, essentially the only thing giving Naftogaz viability on the lending market is the government’s commitment to keep the company afloat.

Efforts to shuttle cheap gas to Ukraine’s residential and so-called “budget” consumers have also led to a stifled internal production market.  Most companies are forced to sell their gas for under $90 per thousand cubic meters, half the price of gas imported from Russia and well below the $300 paid by Ukraine’s industrial consumers.  Forcing domestic producers to pay below-market prices has stunted internal investment, despite a widely-acknowledged potential (though likely not as optimistic as some government figures).  This situation has led to a domestic production sector on the brink, as Max will explain.

A startling reminder of this price disconnect arose when Ukrnafta, Ukraine’s third largest gas producer, severely curtailed production at its gas wells this spring as a result of a pricing dispute with the National Energy Regulatory Committee.  This internal conflict erupted even as Gazprom decreased its gas supplies to Ukraine and over outstanding debt accusations and delay in implementing a new supply scheme.  These dual blows to the natural gas market emphasized the troubles within both the import and the domestic supply sources.

Despite these pressures, it is accepted that an intensive energy efficiency push along with boosted internal production would significantly lower Ukraine’s need for imported natural gas.  Factor in the potential of coal, its related methane reserves, and Black Sea production—issues close to DTEK, as Guerman will discuss—and it is not too hard to imagine a Ukraine that is free to milk profits from its key transit location while relying on its own supplies for much of its consumption.  Even more attractive would be a continued use of relatively cheap Russian and Central Asian gas while exporting Ukraine’s own output westward and responsibly re-investing those profits into infrastructure or production assets.

The likelihood of this happening though, remains slim.  A theme likely to emerge during today’s conversation is the role of government policy in influencing—and often hampering—various energy sphere developments.  That is not to say that politics should not have a role in such topics.  Indeed, proper government incentives could jumpstart Ukraine’s biofuel industry, as Julia will talk about, opening a new source of domestic energy.  Strong political support for projects described at the energy summit—and, just as key, overlapping profitability—can also turn interesting ideas and hot air into concrete steps at illusive “energy security.”

We, as young people, represent the next generation of policy makers.  As such, we must study the current decisions being made and put this knowledge to good use when it becomes our turn to shape our countries’ futures.  At the same time, we should use this engagement as a signal to the leadership that we care about the direction of our countries and are watching with interest.

Update: Please note the location change (now at the Hotel Tourist), which will enable us to accommodate more of the strong response we have gotten. I have also updated the speaker list. You can download the latest schedule here (.doc).

—-

I am organizing an energy policy round table on the afternoon of June 17th, to be held at the Hotel Tourist in Kyiv.

Please contact me (Hans Stege, hstege@gmail.com) if you would like to attend or participate. (Note: All attendees must RSVP so their name can be added to the security checkpoint list.) I will post a more complete schedule as the date approaches, but please find more information below:

“Energy Policy in Ukraine:
Challenges, Opportunities and the Future”

Tuesday, June 17th, 2008
1:00–4:30 P.M.
Small Conference Hall, 7^th Floor, Hotel Tourist
2 R. Okipnoi Street (Livoberezhna Metro), Kyiv

Organized by the Fulbright Program in Ukraine,
the Ukrainian Center for Independent Political Research
and the Forum of Young Leaders of Ukraine.

Participants will make a 10-15 minute presentation on a topic focusing on the challenges and opportunities for establishing policies within Ukraine’s energy sphere. Current topics range from Ukraine’s biofuel production potential to the country’s role as an energy mediator between the European Union and Russia.

The audience will be drawn from some of the foremost student and young leadership organizations in Ukraine.

Following the event, interested attendees will prepare an unofficial report highlighting the questions, concerns and suggestions brought up during the course of the forum. These results will then be delivered to various government entities and industry players.

Join other leading energy industry analysts and observers:

• Vitalii Martyniuk – Ukrainian Center for Independent Political Research
• Tetiana Temnyuk and Taras Dovganiuk– Young Diplomats Club of Ukraine
• Hans Stege – Fulbright Program in Ukraine
• Julia Yatsenko – Nafcom-Agro
• Guerman Ainbinder – Donbas Fuel and Energy Company
• Alexander Todiychuk – Kyiv International Energy Club “Q-Club”
• Anatoliy Baronin - DaVinci AG
• Maxim Vityk - Shell in Ukraine
• Andrew Matheny - Fulbright, PFC Energy