Ukraine-Russia Relations
Letter 1

Lalalu, history check:

1. How about Russia having its borders rolled back to 1147, the year Moscow was founded by Yury Dolgoruki, Prince of Kyiv?

2. How about the Russian defense ministry kicking in a few gigabucks' worth of compensation for Kyiv's successful naval campaigns in 860 and 911?

3. How about the Kremlin confessing trademark infringement of the "Rus" brand, along with the centuries-long practice of cooking history textbooks?

4. How about the Russian finance and transportation ministries setting up a fund to compensate Crimean Tartar repats for their stolen property, perished relatives, and travel expenses?

5. How about Russia the self-appointed successor to the USSR paying damages for things like the Holodomor? In fact, G8 pal Germany is doing just that with regard to the Jews.

6. How about the EU sponsoring a plebiscite in Kaliningrad (former Konigsberg) on whether they want to stay in Russia or join the EU?

Make no mistake: Every stick has two ends. Why get stuck in yet another pot of "bubble Rush-ia" soup?

A Step Closer to WTO Memebership: US Grants Ukraine Market-Economy Status

Deputy Secretary of Commerce David Sampson brought the good news during his recent visit to Kyiv. The event comes as a long awaited achievement prerequisite to Ukraine's accession to the WTO, expected this year. A bilateral protocol on trade will be signed in the near term. Washington and Kyiv will continue their cooperation in nuclear energy. In 2006, a year that will mark the 20th anniversary of the Chernobyl disaster, Ukraine operates four nuclear power plants. However, they do not produce their own fuel. This leaves Ukraine, the country which gave up the world's third largest nuclear arsenal, vulnerable to pressure from Russia, the main supplier. Washington has frowned on Kyiv's pursuit of an in-house refuelling capability. As a compensating measure, US company Westinghouse supplies fuel to one of Ukraine's nuclear power plants.

Cabinet Caps Natural Gas Prices at $110, Concerns Persist

Economics Minister Arseny Yatseniuk recently stated that natural gas prices for manufacturers and consumers would not exceed $110 for a period of five years. A special commission would work out specific rates shortly, he added. This rather upbeat statement may somewhat cushion concerns over price uncertainty that have reverberated in Ukraine since New Year's Day. The last wave of concerns to hit the government involved a confidential protocol to the deal between Naftogaz and RosUkrEnergo. Allegedly, Naftogaz had agreed to have RosUkrEnergo rent its underground gas storage facilities at a heavily reduced rate.

The 95/230 quid pro quo deal may have put quite a few skeletons in the closet. The opposition will be there to do the counting. Any smack of a "sweet surrender" on the part of Ukraine becomes campaign fodder. A Rada investigative panel has already subpoenaed Naftogaz records.

Many analysts doubt that the $110 rate, which does not include VAT and transportation fees, will hold for five years. As energy prices climb worldwide by leaps and bounds, pinning hopes on a price break makes little sense. Naftogaz and RosUkrEnergo already offer different interpretations of the deal. At some point in the future, the genie will be out of the bottle. Russia will insist on a price increase, and Ukraine should be ready.

Even hypothetically speaking, a price lock-in would be a bane rather than a boon to Ukraine. It would kill the incentive to modernize and thus would bury the prospect's of Ukraine's economic development. With far too low a price for far too long, why invest in energy efficient technology, renewables, and cutting edge management techniques? The oligarchs would not move a finger.

Somehow, despite the government's best intentions, a low longterm price appears divorced from reality. And the oligrachs counting on "business as usual" are in the business of fooling themselves. A price hike is just a matter of time — and preparation.

Pricing and Pacing: What Does It Take To Modernize Ukraine's Industry Without Crippling It?

Immediately after UkrGazEnergo, the joint venture between RosUkrEnrgo and Naftogaz, came into being, both parties issued contradictory statements. Naftogaz prided itself on having clinched a deal that had fixed the $95/230 rate for five years. RosUkrEnergo countered that the rate would fluctuate starting with July 1, based on market conditions. So, the question still remains: What does the future hold for Ukraine? How long and how much?

The government struggles to keep the gas issue in good shape. A number of issues such as the deal's monopoly effect, price uncertainty, and corruption associated with RosUkrEnergo have become hot campaign issues. Critics argue that the government is trying to put a good face on what looks like a can of worms.

They say the government has been overgenerous in giving RosUkrEnergo the benefit of the doubt. A company pursuing profit maximization would be loath to burden itself with a 5-year price commitment in a market of rising prices. Those who aim to ride the crest of public opinion by promising a price rollback if "rapport" with Russia is reistablished go even further in misleading the public. As Russia's partners in Ukraine fish for votes, gas makes a good bait. But let's face it: Once the bait is swallowed, there will be no rollback. There need not be. Whoever swallows the bait will be toast, game over. Nor would a cheap price do Ukraine any good, except for the oligarchs.
In the "one company, two stories" puzzle, the question boils down to this: Will the price be high enough to hasten modernization and low enough not to drive the industry bankrupt? Several scenarios merit discussion.

"Too low, too long." An unlikely scenario, will have the oligarchs stick to their guns. Modernization will end up on the backburner. Little investment in energy efficient technology will be forthcoming. The good old boys will keep their old ways, and the whole country will suffer as a result, mired in economic retardation. The more inert the environment, the less innovative the enterprise. And the less innovative the enterprise the more vulnerable it becomes. Should the rug be pulled out from under it, this might be a ticket to the boneyard.

"Too high, too fast." Not an unlikely scenario, may drive the industry bankrupt. Friends come and go, but interests remain. Stabbed in the back, Russia's erstwhile friends, the oligarchs, will have to throw up a white flag. A blowout sale will follow, and Russia will stock up on Ukrainian industrials. Consider it a "scorched earth" policy to make up for Ukraine's impending NATO membership. The best hedge against this scenario is being ahead of the game. To stay in business tomorrow, the oligarchs should start modernizing today. Better safe than sorry.

Somewhere in between these two scary tales falls a relatively high but measured price. Neither amnesia nor paralysis will catalyze Ukraine's modernization. Without having its industry crippled, Ukraine needs core, not cosmetic, changes.

That's why a "sit-back-and-relax" price should not be toyed with, nor should a "swallow-and-die" price be waited for. Get up and go. Don't count on the dice to tell you the price. Set your pace before the price comes blowing in your face.

Joint Venture Yes, Joint Vulture No

A joint venture agreement between NAK Naftogaz and RosUkrEnergo AG will be finalized once RosUkrEnergo comes up with a presentation, Ukrainian Prime Minister Yekhanurov said recently. In a follow-up to the 95/230 deal ending the dispute between Ukraine and Russia, the agreement was supposed to be signed earlier but was postponed for further negotiations. Critics of the deal have openly questioned RosUkrEnergo's credentials, alleging connections to Kremlin associates and a man wanted by the FBI.

Washington has been studying the situation closely and State Department officials have already expressed their concerns. Sensing the buildup, Kyiv has gone out of its way to make sure the joint venture does not look like a "joint vulture." The government is trying to keep its hands clean and its country well supplied through a winter of historically cold temperatures and a torrid parliamentary campaign culminating Mar 26.

Ukraine's Antitrust Comittee gave the green light. The joint venture will be called UkrGazEnergo.