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Ukraine’s Move

September 20, 2006

Op-Ed by M. Ron Wahid and Barton W. Marcois

Ukraine has a choice to make: Will it be a confident, forward-looking state willing to accept foreign investment and embark on a path of rapid economic growth? Or will it be divided, yearning for the past rather than meeting the future?

Earlier this year, Russia was roundly criticized when state-owned gas company Gazprom shut off supplies to Ukraine. Gazprom’s Western European customers, who live further down the same pipelines that run through Ukraine, were left out in the cold too, sparking a debate in Europe about whether the Kremlin was a reliable energy partner.

The four-day standoff ended with a new pact between Moscow and Kiev, but trouble may be looming again. If so, Ukraine may have as much to answer for as Russia this time around.

The Jan. 4 agreement not only preserved Gazprom’s transit rights through Ukraine and moved the company away from the old Soviet system of gas subsidies. It also gave Ukraine two important benefits.

[1] First, it offered a predictable revenue stream from gas-transit fees and the opportunity to buy a large quantity of gas at below-market rates.

[2] Equally important, the agreement was a sign that foreign investors will be treated fairly in Ukraine, which should boost the country’s foreign investment and economic growth.

However, Ukraine’s recent behavior has led many energy observers to fear that it will abrogate the agreement, provoking another showdown with Russia this winter. Gazprom claims there have been unapproved seizures of gas by the Ukrainian gas company Naftogaz in violation of the agreement.

Russia’s response has been mild thus far. But if the dispute is not resolved before winter arrives, the fallout may reduce the amount of gas available for Europe, should Russia take a firmer attitude.

High-level discussions between Kiev and Gazprom are under way to deal with these issues. Though details of the Sept. 13 meeting between Ukrainian Fuel and Energy Minister Yuriy Boyko and Gazprom Chairman Alexei Miller have not been made public, Gazprom says the parties are seeking “to develop long-term interaction on principles of market economy and strategic partnership.”

The condition of Ukraine’s infrastructure is also in doubt. Recent problems with Ukrainian underground storage facilities raise serious questions about their physical stability. If they fail, or even burst, that would threaten the flow of gas to Europe and reduce Ukraine’s own energy reserves.

The agreement clearly defines all rights and duties of the two parties, including Ukraine’s obligations as a transit country, with the common goal of ensuring a smooth supply of gas to Europe. In fact, one benefit of the agreement was to separate Gazprom’s commitment to supply gas to Europe from its supply of gas to Ukraine.

This should have given both Europe and Ukraine comfort that their separate interests would be respected. The transit price was settled for five years in this agreement, and Naftogaz has no right to change it now.

Russia has effectively subsidized the states of the former Soviet Union by supplying energy resources for as little as a quarter of the world market price. But these countries, including Ukraine, cannot be exempt from the world-wide trend of higher gas prices.

The January standoff notwithstanding, Gazprom has sought to move gas prices toward market rates while not disrupting supply.

Despite the rise in price, Ukraine can benefit from honoring the deal in many ways. Higher prices will encourage more efficient use of gas and stimulate investment in energy-saving technologies, increasing Ukraine’s competitiveness.

The time is long past, for both economic and environmental reasons, to reward the inefficient and wasteful use of gas that was the rule during Soviet times.

Instead, Ukraine will move toward European standards of energy consumption. And Ukraine will need to lower subsidies as part of its effort to join the World Trade Organization.

Ukraine has a choice to make: Will it be a confident, forward-looking state willing to accept foreign investment and embark on a path of rapid economic growth? Or will it be divided, yearning for the past rather than meeting the future?

Ironically, it is only by rising above the pains of its past relationship with Russia, not by focusing on a Russian threat, that Ukraine would be best positioned to grow closer to the West. But it is Ukraine’s choice to make.