Robert M. Cutler on Energy and Eurasia

1. Background to the fall of the Yushchenko government

Yushchenko's fall has provoked worries throughout Europe, if not Eurasia. But the no-confidence vote against his government, led by a parliamentary alliance of Communists and allies of "oligarchs" with common cause to oppose real reform in the country, was the culmination of months of increasing scandal and acute political infighting. It hardly spells the end of the story, however.

In recent days, commentators have suggested that President Leonid Kuchma would have liked to be rid of Yushchenko but for the fact that he is looked upon by Western investors (as well as by the Ukrainian public) as honest and incorrupt. A former central banker appointed in December of 1999, Yushchenko had come under fire for introducing austerity and reform measures, including measures to promote transparency and good corporate governance.

His former Deputy Prime Minister Yuliya Tymoshenko, meanwhile, had striven heroically to monetise resource flows in the energy sector and bring the country's energy companies into line with international accounting practices before she was arrested earlier this year. Tymoshenko was detained on embezzlement charges dating back to the mid-1990s, overlapping with the period when she headed United Energy Systems of Ukraine (UESU).

2. The international political economy of Ukraine's pipe production

In 2000, Ukraine produced about 1.5 mm tons of pipes, up nearly 50% from 1999. More than half of all pipes produced in Ukraine last year (800,000 tons, to be precise) went to Russia for use in gas and oil pipeline construction projects.

The Kremlin has accused Ukraine of dumping its pipes on the Russian market, and the two sides have been negotiating over the matter for several months. Barely three weeks before the no-confidence vote, Yushchenko came to an agreement with his Russian counterpart Mikhail Kasyanov on quotas for export of Ukrainian metal pipes to Russia.

Insofar as Ukraine's GDP grew by 5% in the year 2000 and as steel accounts for nearly one sixth of the country's exports, these quotas have the potential to put the brake on the country's recent economic growth. They will almost certainly lead to a restructuring of the industry in the country, as competition among plants for quotas will increase, and the politically less influential plants will be threatened with closure.

(It should be noted that President Kuchma's daughter's common-law husband Viktor Pinchuk, a member of parliament, manages the Interpipe Group, a holding company that controls three of the more important pipe-manufacturing plants in the country.) There is evidence that Moscow's dumping allegations against Kyiv were designed to aggravate Ukraine's economic straits since a crisis would make it easier to obtain control over plants such as the Khartsyszk Pipe Plant that have not yet been privatised.

The Khartsyszk Pipe Plant is the only factory in any CIS country that produces large-diameter anti-corrosive pipes and in fact already provides most of the large-diameter pipes used by Gazprom. The gas monopoly's purchases will be limited under the agreement worked out by Kasyanov and Yushchenko to 135,000 tons, which is 6% less than last year. The remaining 485,000 tons of the quota will be small-diameter pipe, with the level being 25% less than the same figure last year.

3. A wider view of energy in the Russo-Ukrainian equation

On the political side of the balance sheet, Russian pressure also affects the question of the gas transit pipeline through Ukraine to Europe, as well as the agreement reached earlier this year to hook the Ukrainian and Russian electricity grids back together again. The power-grid agreement was crafted partly to provide payment to Russia for Ukrainian firms' admitted pilfering of natural gas piped through Ukraine on its way to Europe. The Ukrainian government specifically agreed to assume responsibility for those gas debts.

One by-product of the agreement, Ukrainian analysts allege, is that local Ukrainian electric companies will be put in an increasingly difficult position as Russia gains the ability to sell electricity in Ukraine. Indeed, the Luhanskoblenergo utility was forced by its creditors into involuntary bankruptcy in April, losing its power grid at an auction and seeing other assets stripped away. Many other oblenergos remain in a precarious financial position. They might have fared better if political conditions were different. Tymoshenko's reforms, had they succeeded, would have served to improve regional utilities' credit and access to capital markets.

Ukraine is also tied to Russia in other ways; for one, it imports Turkmenistani gas via the Russian pipeline system. At the recent Turcophone summit in Ankara, Turkmenistan's President Saparmurad Niyazov claimed that he would soon sign an agreement for Ukraine to import 50 bn cm of his country's gas annually, although he did not mention a price. Interestingly, this 50 bn cm figure was the amount announced in Ashgabat last July by Turkmenistan's Deputy Prime Minister Yolly Gurbanmuradov after talks there with Tymoshenko. Yet Kuchma immediately denounced Tymoshenko's deal, saying it was non-binding and void because only he, and not his deputy prime minister, had the authority to sign even framework agreements with President Niyazov.

4. Ukraine and Europe's energy in new perspective

Yushchenko's efforts to promote the establishment of an oil transit corridor between Azerbaijan and Poland, to be developed under the European Union's TRACECA project, probably did not help improve his stature in Moscow's eyes. Such a corridor would circumvent the route to Novorossiisk on Russia's Black Sea coast. According to industry observers, Ukraine could not fill the Brody-Odessa line because it cannot buy the oil for it. Moreover, without a northern extension to Poland (currently being evaluated for feasibility), the pipeline could take oil only to Hungary, Slovakia, and the Czech Republic.

However, investors do not appear interested in building the Ukraine-Poland leg of the project. Even Yushchenko's announcement that the Ukrainian section of this Odessa-Brody oil pipeline and the Yuzhny oil terminal near Odessa were 90 % complete was insufficient to cause EU leaders to take notice of Ukraine's plight at their latest summit. It could also well be that the EU is simply more interested in natural gas. If so, then it is noteworthy that Gazprom continues to study pipeline routes to Europe that circumnavigate Ukraine.

Indeed, recently it has been reported that an international consortium has signed a letter of intent with Poland's state energy company PGNiG to conduct a feasibility study of three routes from Belarus through Poland and Slovakia to European markets. The consortium includes Gazprom, Gaz de France, Snam of Italy and the German companies Ruhrgas and Wintershall.

Earlier this year, Poland balked at participating in any pipeline that would bypass Ukraine. But two considerations probably persuaded PGNiG to participate in the study—first, the economic advantage to be obtained as European demand for natural gas increases in coming decades and second, reports that Gazprom was considering a pipeline through the Baltics and undersea to Germany, thus bypassing Poland as well as Ukraine.

5. From local geo-economics to regional geopolitics

Newly independent Ukraine's relations with "Europe" underwent an important shift in the mid-1990s; indeed, the G-7 meeting held in late 1994 in Winnipeg, Canada, was dedicated almost entirely to examining and promoting Ukrainian reform. This event gave a big boost to Ukraine's aspirations to "join" the West, and the pre-eminent symbol of such acceptance was the country's 1995 admission to the Council of Europe as well as its simultaneous signature of a Partnership and Cooperation Agreement with the European Union. The Ukrainian leadership of the time thought these achievements showed Moscow that the Europeans considered Kyiv a partner of mainstream Europe.

However, Ukraine never shook off its dependence on Russia for energy supplies, and this issue has now proven an Achilles' heel. Ukraine's best chance in Europe is to serve as a bridge between Russia and the West, and knowledgeable observers suggest that Yushchenko's fall is part and parcel Ukraine's necessary efforts to balance between the economic pull to the East and the political aspirations to the West. The question is how far and how much Ukraine will be pulled back into Russia's orbit under current circumstances.

The problem is that what began as an eastward tendency last year with the replacement of Yushchenko's foreign minister by a Moscow-oriented functionary has now taken on a momentum of its own. That momentum appears to accelerate with the covert involvement in Ukrainian affairs by different economic Russian interests that share the antipathy of Ukraine's own "oligarchs" or "tycoons" to reform in their own country. It is these transnational interests that have allied with the Communists in the Rada to bring down Yushchenko, while the centre and moderate political parties are more concerned with making political hay for their own short-term benefit.

6. From regional geopolitics to the spirit of the times

Government leaderships in Moldova and Ukraine are moving spiritually eastward, political and economic crises are deepening in Uzbekistan, even Azerbaijan is moving closer to Russia (perhaps even in energy matters) and Georgia remains beset by domestic ethnic instability exacerbated by Russian moves earlier this year regarding the bilateral visa regime and energy transfers.

On top of all that, Yushchenko's fall puts another nail into the coffin of GUUAM, the Georgia-Ukraine-Azerbaijan-Moldova entente born in 1997 and joined by Uzbekistan in 1999. GUUAM was established due to shared insecurity about Russia but never developed into a full-fledged international institution.
The entente was to have held a summit this spring where such founding documents would have been signed and a series of councils and forums for consultation and cooperation been established across the executive and legislative branches of all participating governments. However, recent elections in Moldova, which saw a Russia-oriented communist leadership return to power, cast that into doubt earlier this year. Afterwards, even Azerbaijan found it difficult to confirm a date for its attendance at the ceremonies.

It is true that GUUAM developed out of the Georgia-Azerbaijan energy corridor agreements struck between Georgian President Eduard Shevardnadze and Azerbaijan's President Aliyev in the mid-1990s, when the two leaders realized they both faced internal ethnic and civil unrest, blame for fomenting which could easily be laid at Russia's door. But with the development of the European Union's TRACECA program as from about that time, and with all the other institutional opportunities for cooperation, GUUAM as an energy corridor never really caught on.

7. From the spirit of the times back to post-Soviet energy

GUUAM was touted by its backers, including those in Washington, as a cooperative structure for finding routes to take Caspian energy to Western markets. In truth, there was never much substance to such a claim. There was, rather, a tendency by Western backers to attribute any bilateral or multilateral cooperation among GUUAM's participating states to the (ephemeral) existence of the entente, as if calling it GUUAM made it so. Today in Ukraine, observers look at the no longer altogether laughable prospect of Moldova joining the Russia-Belarus union and fear a "geographical horseshoe" collaring their country. Indeed, Ukraine's accession to such a union will probably become a more lively topic in the country's domestic politics in the near future.

Last year and early this year, Ukraine became a driving force for integrating the GUUAM countries' various initiatives into a comprehensive framework that might possibly mean something. This made sense, insofar as Ukraine was, among the five, certainly the weightiest participant from an economic as well as geopolitical standpoint. However, GUUAM was always a security (or insecurity) entente. Now that the balance of domestic politics in several of the GUUAM states has shifted national leaderships' security perceptions, Western political leaders have been caught unawares. More likely, they were just busy with other matters.

A good number of attempts were made at the think-tank and ministerial levels in Western countries to get attention focused on Ukraine, but these did not seem to bubble up to the level of national executive decision-making. Even when they provided some focus, that focus did not connect with the pressing issue of economic reform in the country. The increasing political chaos in Ukraine, where the president is implicated in a critical journalist's disappearance and likely murder and where the constitution does not contain a provision for his impeachment, even Ukrainian politicians have been distracted from what really matters.

It is not even clear that Ukraine as a whole will reap any energy-related benefit from its deepening relations with Russia, as Russia gives every appearance of being set to bypass Ukraine in sending its own natural gas to Europe. Meanwhile, according to Ukrainian press reports, one individual well placed to benefit from the oncoming shake-out in the Ukraine pipeline-production industry is—as noted above—the common-law husband of President Kuchma's daughter, the manager of a holding company called the Interpipe Group and himself a member of parliament who supported the no-confidence motion against Yushchenko.

Copyright © Robert M. Cutler unless otherwise noted.
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First published in FSU Oil & Gas Monitor, No. 130 (2 May 2001): 2–4.