Robert M. Cutler on Energy and Eurasia

1. Results of Niyazov's visit to Kyiv

According to reports from Kyiv, as many as 10 bilateral agreements were signed on May 14 during Niyazov's visit to Ukraine. These include a long-term trade cooperation agreement lasting until 2010, a long-term economic cooperation agreement with the same duration that includes an agreement on natural gas supplies, a separate contract between the two state enterprises Turkmengaz and Naftogaz Ukrainy on the purchase of gas from Turkmenistan for the year 2002, plus a half-dozen other agreements on cooperation in spheres ranging from the pharmaceutical industry to taxation to mutual recognition of diplomas and academic degrees as well as two agreements on international migration.

Beyond these agreements, reports from Kyiv also indicate that Turkmenistan is planning to give land to Ukraine for the purpose of developing cooperation further in the sphere of energy production. Further reports indicate that Niyazov is considering inviting Ukrainian specialists to extract oil in the Amu-Darya River estuary and at offshore fields in the sector of the Caspian Sea that Turkmenistan claims for itself. The latter, if true, would be quite a shift from the country's stated position that all offshore development should await the conclusion of a general agreement among all five littoral states on the status of the Caspian under international law.

The most interesting accord signed on May 14 is the one calling for Turkmenistan to provide Ukraine with 250 billion cubic meters (bcm) of natural gas over a five-year period, from 2002 through 2006. According to Niyazov's public statements, 40 bcm will be delivered in 2002 at a price of $42 per thousand cubic meters (tcm). Then in 2003, 50 bcm will be delivered, with volumes increasing in subsequent years. If the quotas for 2002 and 2003 are not overfulfilled, the average level of deliveries for 2004-2006 would be 53.3 bcm; but clearly the 250 bcm figure is just a round number chosen to guide future developments.

2. Background to the Turkmenistani-Ukrainian energy trade

Ukraine is historically the principal consumer of Turkmenistan's natural gas, and Turkmenistani gas arrearage accounts for a substantial portion of the country's total debt load. As far back as the mid-1990s, international financial institutions were trying to find a way to regularize payment regimes after the disintegration of the Soviet Union and later dissolution of the ruble zone. The United States also tried to help with loans and grants to Ukraine which were immediately given over to Turkmenistan to try to settle payments problems. But the issues were never really resolved, so Turkmenistan halted gas exports to Ukraine in 1997 retribution for payment problems.

As a result, Turkmenistan's overall gas sales plummeted in 1998, though they have been recovering since. Thus when sales of Turkmenistan's gas, which represent about two fifths of the country's total exports, increased by two thirds in the first half of 1999 by comparison with the same period in 1998 (from 13.3 bcm to 22.4 bcm), this was due mostly to renewed exports to Ukraine. When a later deal, reached in 1999, eventually fell through because of Kyiv's payment difficulties, a contract with Russia took up the slack.

So far as settling old debts is concerned, Niyazov said in Kyiv that an understanding had been reached whereby the total amount owed was set at $420 mm, of which 90% would be paid in cash and the remainder through Ukrainian investment projects in Turkmenistan. (Turkmenistan now also plans to buy agricultural machinery from Ukraine.)According to a statement made by Niyazov at a government session, Turkmenistan's state debt now amounts to $1.6 billion, of which two thirds is owed for reconstruction of the oil refinery in the port city of Turkmenbashi. This amount is equal to that owed to Turkmenistan by other countries, mostly by Ukraine and Georgia.

Mollifying his previous position, Niyazov said he would wait until Ukraine settled its debt questions with the Paris Club before having the requisite documents drawn up. Whereas Russia and Ukraine seem to dispute interminably over amounts of gas traded between the two countries, including the question of Ukrainian pilfering, no such problems appear to mar Ukraine's relations with Turkmenistan. Indeed, Niyazov publicly stated that Ukraine is "very accurate in its accounts with Turkmenistan."

3. Where Russia comes in

In a remarkable way, these accords parallel public announcements made exactly one year ago during Russian President Vladimir Putin's visit to Ashgabat in May of 2001, an agreement in principle to increase Russian gas purchases from Turkmenistan was reached. The TCGP project had just reached a definitive standstill early that spring. Gazprom chief Rem Vyakhirev talked with Niyazov as the last major round of TCGP negotiations were failing, and Putin travelled to Ashgabat about a month after then-US Secretary of State Madeleine Albright spent a week making the rounds in Kazakhstan, Kyrgyzstan and Uzbekistan.

Turkmenistan had previously suspended deliveries to Russia due to a price dispute in 1997, insisting that the rate offered by Gazprom of $32/tcm was too low. In December of 1999, Russia's Gazprom reiterated its offer and said it would make 70% of payments due in barter and 30% in cash. Turkmenistan insisted on a price of $40-42/tcm with Gazprom to pay 50% of its bill in cash, and a compromise was reached at $36/tcm with 40% in cash.

The accord announced during Putin's visit to Ashgabat a year ago renewed and expanded agreement struck between the two countries in December of 1999, which provided for Turkmenistan to export 20 bcm during the calendar year 2000 and to increase this figure by 10 bcm per year (bcm/y) for three to four years until import levels reached 50-60 bcm/y, then to continue at that level for the remainder of the decade. But these quantities only inaugurated another dispute over price after Putin's visit to Ashgabat. At first, Itera, the Russian company that was to transport the gas from Turkmenistan rejected Niyazov's asking price of $46/tcm and announced that even $36/tcm would be too high.

Subsequent reports placed Russia's bid at between $32 and $34 (with 40% of the total price in cash), with Turkmenistan's offer at $40 to $42. In early September of 2000, Russia agreed to pay $38/tcm for 10 bcm of additional gas during 2000, above the 20 bcm previously contracted. However, as negotiations with the Russian side over price failed to bear fruit, Niyazov announced early this year that he would renege on the longer-term agreement in principle with Russia. In particular, he said he would observe it only through 2002 or 2003 and that subsequent volumes would have to be discussed later.

By early this year, a cat-and-mouse game was underway. Russia needed the gas, but Itera was not willing to meet Niyazov's price demands. So in early 2001, Niyazov shut off Turkmenistani gas flows to Russia. But when he wanted to restart deliveries, he was told there was a problem and, with a foreign-exchange crisis mounting, he ended up having to ask Itera to allow him to put the gas back into the pipelines. Niyazov subsequently decreased his long-term price demand from $42/tcm to $40 but Itera, which had begun by insisting on its price for earlier deliveries of $36, had not raised this above $38. And there things stood until the recent agreement with Ukraine.

4. The fine print of the current agreement is not set

The price of $42/tcm is not the price for final delivery to Ukraine. Nevertheless, it is interesting that it is the same price as agreed during a visit to Ashgabat by then-Deputy Prime Minister Yuliya Tymoshenko in late July of 2000 for gas delivered to Ukraine at Turkmenistan's border with Uzbekistan. At the time, Tymoshenko estimated the final delivery price to Ukraine, through Russia, at $103/tcm. (The visit by Niyazov to Kyiv this month was a return of the visit made by a Ukrainian delegation headed by Volodymyr Lytvyn, the chief of the presidential administration, last September; Lytvyn contradicted Tymoshenko, saying the price of the gas would rise to $113/tcm by the time it reached Ukraine through the Russian pipeline system.)

Tymoshenko said that gas from Turkmenistan would cost a maximum of $50/tcm at Ukraine's border with Russia, but this was possible only if one assumed that Ukraine received $2 billion per year from Russia in payment for transit of Russian gas to Europe. Russia has paid that cost in kind rather than in cash, and a monetization of these transfers is now highly unlikely. Itera informally agreed at the time that Turkmenistani gas could arrive in Ukraine at the price of $50/tcm, including transit through Russia, but only after contractual formalities were concluded between Ukraine and Turkmenistan. These formalities remain to be concluded despite the agreement in Kyiv, which is only a framework understanding.

Itera further stated last year that such a price would not include charges to Ukraine for transportation of Turkmenistani gas through Uzbekistan and Kazakhstan on its way to Russia. These fees, Itera said, would be subject to negotiation, pending completion of the Ukraine-Turkmenistan agreement. In view of the still-unresolved transportation charges, the final cost of the gas to Ukraine has clearly still not been settled, and the agreement depends upon their resolution.

5. And Turkmenistan's finances remain precarious

A report by Turkmenistan's National Institute for State Statistics and Information carried on a Russian-language website asserts that Turkmenistan saw its output of oil and gas condensate increase during the first four months of 2001 by 10% and of natural gas by 23% compared to the same period last year. The figure given for natural gas output was 18.7 bcm, while gas exports increased 34% to 12.8 bcm.

Nevertheless, the difficulties of verifying statistical information from Turkmenistan were made apparent by reports stating that the international ratings agency Fitch IBCA had downgraded Turkmenistan's long-term foreign currency rating from B- to CCC- and its short-term foreign currency rating from C to B.

Fitch specifically cited the "opaque nature of policymaking and lack of reliable economic information" and the absence of transparent and predictable debt servicing as reasons for the downgrade. Part of the problem may be Niyazov's insistence that all state-owned and private organizations conclude their insurance contracts with Turkmendovletatiyachlyk, the state insurance inspectorate, which he claims is more reliable than any private firm.

Also symptomatic of such difficulties was Niyazov's reported statement earlier this month, before leaving for Kyiv, that the country owed "not a cent" to foreign creditors. Ashgabat in fact owes $1.1 billion, but Niyazov said this sum would be repaid only when his government was ready to do so, specifically with the proceeds from the petroleum-refining sector of the national economy.

According to reports from Ashgabat, Niyazov's intention is for the Turkmenbashi refinery to become the most sophisticated in Central Asia. The facility has been overhauled as part of a program to increase Turkmenistan's production of finished petroleum products for export. Its cracking facility now refines crude into high-octane gasoline, diesel fuel, furnace fuel and liquefied gas. Polymer production is due to begin later this year.

6. The broader view

Kuchma observed at the signing that the Turkmenistani gas deal was a question "not only [of] economics, but also an important policy [concerning] the country's security." Still, his claim that the deal will satisfy his country's energy needs "nearly in full" and eliminate dependence on Russia rings a bit hollow. The country consumes about 80 bcm/y of gas. On top of 30 bcm contracted for purchase during the current year, Kuchma is calculating domestic production at 18 bcm.

However, not only is Kuchma counting on 30 bcm of in-kind payment by Russia for transit of Russian gas through Ukraine to Europe, but also Russian pipelines will continue to furnish the transportation for Turkmenistan's gas to Ukraine. It would therefore be a bit of an overstatement, not to say a misrepresentation, to suggest that Ukraine's dependence on Russia is at an end.

This signifies that the questions whispered about Russo-centric strategic political realignments in Central Asia a year ago have migrated eastwards. The summit meeting of the GUUAM (Georgia-Ukraine-Uzbekistan-Azerbaijan-Moldova), which would have institutionalized the entente founded on common threat perceptions, has been indefinitely postponed following the election of a pro-Moscow regime in Moldova. On the heels of that development came the ouster of the Yushchenko government in Ukraine, itself following upon the energy-sector reformist Tymoshenko's resignation from the government, in the wake of what looks to most observers -- whether inside or outside Ukraine -- like an orchestrated political scandal.

Since then, Russia has coaxed Azerbaijan into a position sympathetic with Moscow's stand on Caspian Sea demarcation and enforced oil throughput agreements from the mid-1990s that compel the State Oil Company of Azerbaijan (SOCAR) to export significant amounts of its production through the Russian port of Novorossiisk on the Black Sea, via a detour through Dagestan around Chechnya. Earlier this year, Russia has also flexed its muscle in Georgia's direction with the cut-off of prepaid gas supplies that aroused such indignation in Western diplomatic circles.

7. The strategic significance

When Secretary Albright visited Uzbekistan in April of 2000, the impression in Tashkent was that she was there because of a perception of Tashkent's rapprochement with Moscow. After she left, Uzbekistan's President Islam Karimov met with Putin and declared that there was no divergence between the two countries' interests. This year he declared Russia a "strategic partner," a significant locution that he eagerly sought from the United States, which designated him officially a strategic partner in the mid-1990s. Now he wants to be Russia's.

Putin's focus on Central Asia, starting last year, was qualitatively new in the post-Kozyrev period. Boris Yeltsin's foreign minister Yevgeni Primakov's attention in Asia went to traditional Soviet allies such as Iran, India and China. Under Primakov, a "Eurasianist" strand did enter post-Soviet Russian foreign policy in the mid-1990s. But NATO's intervention in the Balkans and its encroachment into former Soviet bloc countries have greatly strained ties with Russia and exacerbated this "Eurasianist" strand.

Russia's turn to focus on Central Asia was in part an expression of its exasperation with what it sees as NATO's intrusions into the South Caucasus. Now through a series of events that have taken on a life of their own, it has found Moldova, Ukraine and to a degree Azerbaijan returned to its sphere. Insofar as this is at least partly based on the coordination of the processing of raw materials and natural resource extraction, we may expect that economic cooperation under the aegis of the Commonwealth of Independent States (CIS) may even become more enhanced.

Failing that, or even more likely than that, we may expect political voices in Ukraine to begin to call for joining the Russia-Belarus union and the Eurasian Economic Community (formerly the "CIS Customs Union") set up by Belarus, Russia, Kazakhstan, Kyrgyzstan and Tajikistan.

Copyright © Robert M. Cutler unless otherwise noted.
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First published in FSU Oil & Gas Monitor, No. 133 (23 May 2001): 3–5.