Ukraine - A Transit Country in Deadlock? Four Scenarios Notes de l'Ifri, December 2009

Will there be a new transit crisis this winter? Failure by Ukraine to honor its payment deadlines on the 7th of each month would certainly precipitate it, and that possibility cannot be excluded. Both on the Ukrainian and on the Russian side, a number of factors exist that, combined, could easily trigger a domino effect whereby the situation would become uncontrollable, as was the case in January 2009. Tension has decreased, though, between Russia and Ukraine following the Yalta meeting of CIS prime ministers in mid-November, which is good news. But the risk of a drop of the Hryvnia value and the resulting payment default in January cannot be written off.

Any analysis on Ukraine is a challenge at a moment when information is contradictory and can swing from the assertion of a lull to a red alert in the matter of no time. It is important to highlight the chronic aspects of the Ukrainian situation, which are likely to stay so after the January/February 2010 presidential election: extreme instability, and political and economic volatility and weakness.

Transit has been an acknowledged symbol of Ukrainian identity ever since the country became independent at the end of 1991. It epitomises the position occupied by Ukraine on the European map, at crossroads between Russia and the European Union - a positionning likely to reveal itself as more stable and definitive than might be thought.

The relevance attributed to transit is justified by its impact not just on the European Union but also on Russia and the Central Asian producers. Thus, in its current capacity as an energy bridge -or should we say energy barrier instead? – Ukraine attracts massive international attention, for the good and for the bad. In various senses, the contradictions embodied by this vast country are a fine mirror of European oriental cultures and their history.

Kiev worries its neighbours and the international community because of its random and contradictory governance, its populist policies that prevail over any project formulated by the citizens or the politicians, and its economic collapse linked to the absence of coherent strategies and the constant delay of durable reforms. Ultimately, and regardless of its merits concerning freedom of the press or human rights, the Orange Revolution has come to be widely perceived as a failure and a wasted opportunity. On the political and economic fronts, governance has fallen short of the orange ambitions; and since 1994, uninterruptedly, the country has been trapped into short-term and clannish approaches.

Such a state of affairs has had direct consequences for the EU as far as energy transit is concerned - a situation that will not change at least for the next five years and then, yet, only provided the will for change exists. A quarter of the gas consumed in the EU comes from Russia and Central Asia, and 80% of that amount passes through Ukraine. Naturally, the EU cannot allow itself to neglect the risk that an amplified Ukrainian crisis would pose on the stability of the Union as a whole, considering the size of the surface and the population of the country.

Quite clearly, the Russian-Ukrainian dispute cannot alone supply all the answers to the question of why the transit crises have taken place - the “small one” in 2006 and then the “big one” in 2009. Western media tend to fixate on the Russian-Ukrainian roots of the crisis and public opinion then finds it easy to condemn one or the other side, according to received wisdom and based on the most convincing arguments. This approach entails the risk of neglecting other fundamental elements that also constitute the background of the crisis.

For a long time, political inefficiency has frustrated reform initiatives and the expectations of Ukraine’s partners, the International Financial Institutions (IFI). The country appears incapable of engagement. Its energy (in)efficiency explains not only its huge gas consumption but also its excessive dependence on Russian and Central Asian supplies. Treaties can be dismissed as soon as they are signed, and daily bargaining among those in office wins the day over the idea of pacta sunt servanda. International trust in the reliability and firmness of Ukrainian policy has been dented, and the EU has become weary of the ups and downs of the politicians" brawls, the quarrels among the former Soviet countries, and blackmail on the lines of “if you guys don’t act now, tomorrow we will be Russian”. On all these issues, a long-term EU vision comes up against a very short-sighted approach that the author suggests calling “spot governance”, the absence of a rule-of-law culture, official unaccountability inherited from 70 years of Soviet experience, and a clannish way of running business to the detriment of the common good.

Acknowledging the responsibility that befalls these Ukrainian downsides should in no way be taken as an invitation to neglect the bilateral nature of the conflict, nor Moscow’s own designs -first and foremost its quest for control over the Ukrainian gas network- nor even the goals and limits of EU policy. The methodology proposed by the author advocates the necessity to take all of those factors into account in the effort to elucidate Ukraine’s current predicament.

The goal of the present study is to highlight Ukraine’s role in the landscape of gas transit, while considering and analysing the existing information on fields that are larger than the gas issue, i.e. Ukrainian politics and economy and, above all, the country’s energy policy. The study will then review the January 2009 gas crisis and Brussels relations with Kiev. First introduced in a summary fashion, the information will then be analysed. The resulting overall background picture should be a useful tool to help observers and decision-makers find their way through the highly complex context.

The study is structured as follows:

- A first part on the economic and political background introduces the main elements of the current Ukrainian situation;

- the second part is devoted to energy and each one of its variants: mix, oil, coal, and above all, gas;

- the third part develops the January 2009 Russian-Ukrainian conflict; and

- the fourth part concentrates on EU policy towards Ukraine.

The last part presents four scenarios in all of which governance and the gas transport network are the key elements. The decisions taken concerning the future of the transport network will determine the country’s chances to modernise, build trust and keep the fortuitous role that the Soviet heritage bestowed upon it. Ukraine has, indeed, the options to stay in chronic deadlock and eventually collapse, enter a multilateral consortium alongside the EU and Russia, hand over the network’s governance to the East, or go the Western way. Presented in a nutshell, the last option would entail the introduction of EU conduct codes in the Ukrainian energy sector whereby membership to the Energy Community would be a first step, to be followed by public -and hopefully also private- Western financial contribution to the modernisation task. In the current context, Ukraine’s gas policy symbolises -far more than any other national parameter- the stakes laying ahead of the country in a much larger sense.

The author believes that, paradoxically, the current economic situation could play in favour of an important role for Ukraine. European and international gas market prospective studies forecast abundance of supply (IEA 2009, EU Trends towards 2030) and availability of cheap gas - none of which facts is of good omen for the future alternative projects of bypassing the existing Ukrainian route. In the light of this, wouldn’t just some political effort from Kiev be enough to allow Ukraine to retain its current position?

The material base for this report comes from the documents and publications listed in the bibliography, as well as from interviews with EU, Ukrainian and Russian experts and decision-makers. A field mission to Ukraine was undertaken between October 6th and 10th 2009, and meetings were held with representatives of national and international institutions, experts, company officers and researchers. The author is indebted to all her interlocutors -Serhiy Pavlusha, Bogdan Sokolovski, Irina Akimova, Faouzi Bensarsa, Volodomyr Omelchenko, Max Alier, Simon Pirani, Jonathan Stern, Ralf Dickel, Valerij Tsaplin, Olivier Silla, Nico Lange, Slavtcho Neytchev, Kyriakos Morfis, Oleksandr Todiychuk, and Michail Gonchar- for their hospitality, advice and availability. The Ifri energy program colleagues Jacques Lesourne, William C. Ramsay, Maïté Jaureguy-Naudin and Christian Schülke have, as always, supplied good and constructive advice. Marina Gaillard provided efficient reading. The views held in this paper are the sole responsibility of the author.