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Energy geopolicy of the Ukraine

Todor Kondakov, Ph.D. - 8/1/2006

It is a well-known fact that the present authorities in the Ukraine consider the energy independency of the country from Russia for the topmost national priority. Over 90% of the deliveries of Russian natural gas for Europe go via this country and Belarus. But if Russian energy companies can reach agreements with Belarus, which is considered as a solid ally of Moscow's, the Ukraine has become a real nightmare for Kremlin after the victory of the "orange revolution". Furthermore, this does not concern the mere transit of energy raw materials for Europe - a much greater challenge is posed by the possibility that this country adopts the role of a military-strategic base of the US, which is the aim of the persistent efforts of its current leaders and which poses a serious problem for Russian security.

If we look objectively, the Urkaine has the ideal geographic location as it is a convenient corridor for the transportation of oil and natural gas from the Caspian region to Western markets. The most appropriate facility in this respect is the pipeline Odessa - Brody, which was completed in 2001 and can be extended to the Polish city of Plotsk and further to the Baltic port of Gdansk.

The implementation of this plan, though, has met the resistance on the part of Russia, which firmly insists on its right to utilize the pipeline in the reverse direction - in other words, for the transit of Russian oil to the South and further via the Black Sea to world markets. Moreover, Moscow is trying to get the Ukraine involved into the customs and economic alliance of the so-called Common Economic Space (embracing Russia, Belarus and Kazakhstan).

The Ukrainian politicians, who came into power after the "orange revolution", were predisposed to sever the links with Russia for a number of reasons. On the other hand, though, Russia is strongly concerned about the existence of numerous negative tendencies in the current Ukrainian policy. These are Kiev's attempts at joining the NATO, the ongoing discussions on the destiny of the Black sea fleet and the border dispute on Azovian Sea, which was intentionally pushed to a dead-end by the Ukrainians.

The declining living standards in the Ukraine are only one of the consequences from the "orange revolution" and the aggravated relations with Russia. Another and even greater challenge was the energy crisis, which culminated in the "gas scandal" between the two countries, which in its turn was concluded in January 2006.

It is hardly surprising that Kiev is actively searching for alternatives to the Russian energy resources, which are of crucial importance for overcoming the forthcoming economic collapse. Further to that, President Yushchenko and his circle, who continuously underline their adherence to democratic values, are ready to cooperate with any "authoritative" regime from the Post-Soviet space as long as gas and oil problems of the Urkaine are thereby solved. Thus, the visits of the Ukrainian leader in the spring of 2005 in Turkmenistan and Kazakhstan were dictated by his intention to establish with these countries a new energy alliance, excluding Russia (this would be a gas alliance with Turkmenistan and an oil alliance with Kazakhstan, respectively). Further to that, Yushchenko tried to reach agreement with Turkmeni President, Saparmurat Niyazov (Turkmenbashi), on alternatives to Russian gas in parallel with the preparations for talks on the establishment of a Russian - Ukrainian - German consortium for the development of Ukrainian gas transportation networks.

Although any cooperation between Kiev and the famous for his capriciousness Turkmenbashi would undoubtedly be highly problematic and therefore Moscow as a reliable commercial partner undoubtedly is the preferable option. Still, the geopolitical (or rather, the ideological) imperative here - the drive towards lesser dependency on Russia - prevailed over economic expediency. It is quite a different matter that Yushchenko failed to convince the Turkmeni President in the advantages of his project and Ashgabat refused to yield as regards the prices of its natural gas. Niyazov himself preferred not to sever the links with Moscow for a good reason instead of concluding new contracts with Kiev. In October 2005 he welcomed in Ashgabat the Ukrainian Minister of Energy and the General Manager of Naftogas of Ukraine (NOU) and directly told them that he would not tolerate the breach of any already concluded agreements on the delivery of goods and equipment against covering the clearing debt for delivered natural gas. "Each time you promise that you will pay your debt in six months but in practice you do nothing", stated the President, underlining the fact that out of USD 484 million, which is the total amount of the debt, only 8.7 million have been covered through the delivered goods from the Ukraine.

He voiced his complaints to the management of the Ukrainian energy complex for deferring the implementation of investment projects, funded at the expense of Turkmeni gas deliveries. Thus, in actual fact there is no progress as regards the construction of the railway bridge over Amudarya. Turkmeni leader specifically underlined the fact that long-term gas cooperation with the Ukraine should be developed, taking into account the interests of the third partner - i.e. Russia - and appealed to the Ukrainians to observe the already concluded agreements. An extremely unpleasant surprise for NOU was the aspiration of Russain Gazprom to break free from its Ukrainian dependency as regards the deliveries of natural gas for Europe. It is a well-known fact that Moscow has already signed the first contract for gas deliveries through the future North European gas pipeline, which will bypass the Ukraine.

Searching for an alternative source of the much needed for Ukrainian economy "black gold", Kiev set great hopes on Kazakhstan. The latter has significant potential for boosting up its exports; is interested in the diversification of its economic relations and what is most important can guarantee stable deliveries. Taking this fact into account, the Ukraine intends to reduce the volumes of Russian oil it procures at the expense of partial reorientation to Kazakh oil. One of the possible ways of achieving this is through handing over to Kazakhstan of Odessa oil refinery. It is true that currently this refinery is owned by the Russian giant Lukoil, but taking account of the avalanche-like re-privatization process in "post-revolutionary" Ukraine, we are not to exclude the possibility for the refinery to change its owner - from Russian to Kazakh.

Kiev relies upon "neutralizing" Russia and convincing it together with Kazakhstan to agree to the establishment of a sort of palliative to the Common Economic Space (CES) - the so-called "free trade zone". The benefits from this project for the Ukraine are obvious: having in mind its strategy for EU integration, the country will not have to conform with the supranational bodies the Common Economic Space. Further to that, the Ukraine will be in the position to make high profits from transit to the East and mostly to Russia of an uncontrollable amount of Western goods. Kiev has some very particular strategic ambitions as well: the Ukrainians for example intend to make use of cosmic infrastructure at Baikonur. Thus, Viktor Yushchenko already announced in Astana that he will offer to Russia and Kazakhstan that the complex for launching of Zenith rockets, which were hitherto launched from the floating platform "Odyssey" in the Pacific Ocean, be transferred to Baikonur. Having in mind the fact that Zenith rockets are a conversion of war rockets, developed by Ukrainian military concern SDB (State Design Burearu "Yuzhnoe") and produced in Dnipropetrovsk, then Kiev obviously has some substantial trumps at hand.

Nevertheless, Astana did not react posititively to Viktor Yushchenko's proposals. Furthermore, the Ukrainian leader, who constantly claims that the integration of the country into European and Euro-Atlantic structures is his main priority, had to negotiate in Astana with his Kazakh counterpart, who is known for being the foremost and staunchest ideologist of the "Eurasian integration".

It is not surprising after all that Nazarbaev advised Yushchenko to try solving any issues within the CES in the future, which in itself meant that Kazakhstan refuses to develop relations with the Ukraine at Moscow's expense. Nazarbaev also mentioned that all issues, related to the transportation of oil for the Ukraine, should be coordinated with Russia in advance, underlining the fact that the largest Eurasian country cannot by bypassed anyway - o matter how much the Ukrainian President may wish this - neither literally (i.e. geographically), nor metaphorically (i.e. politically and economically). As regards the reaction of the Kazakh leader to the Ukrainian project for the establishment of a "free trade zone", it was biting and particular and demonstrated even at his meeting with Byelorussian President Lukashenko in May 2005, when Nazarbaev state that if the Ukraine is not satisfied with the "foursome" format of the CES, then it can easily become "threesome".

In actual fact, the greatest problem of the Ukrainians is that the procurement of Kazakh oil would be economically justified by them only if its price is less than the price of Russian oil. It is said that during initial talks with Astana, Kazakhstan agreed to sell its energy raw materials at a price, which is a little below the Russian one - USD 305 - 310 per ton. Still, this does not solve the problem with oil transportation. In 2005 and 2006 the oil transportation charges by rail increased. Even if Astana agrees to get these deliveries started, some other serious problems will arise. First, Ukrainian oil refineries will have to be fully re-equipped as they are currently adapted for the processing of Russian oil, the characteristics of which differ from those of Kazakh oil. Second, the refineries in Lisichansk and Kremchug, which should process Kazakh oil, are owned by Russian investors. The latter would hardly be much enthusiastic about the prospects for processing "foreign" oil.

Meanwhile, Kazakhstan has already raised the questions (although only theoretically) about its potential involvement in the operation of Odessa - Brody oil pipeline. The problem was discussed during Ukrainian - Kazakh talks on plans for establishment of a consortium with the participation of Azerbaijan, Kazakhstan and Georgia. This consortium should undertake the functions of transportation operator for Caspian oil (Kazakh, Azeri, Turkmeni) through Baku - Supsa oil pipeline and from there - to Odessa. The Chairman of the Managing Board of NOU does not exclude the option for averse (i.e. direct) operation of the pipeline by end-2006 (as I mentioned above, this pipeline has been operation for almost five years in reverse direction, i.e to the South in the direction of the Black Sea).

Generally speaking, the extension of Odessa - Brody oil pipeline in the north direction brings forth some serious rivalry on geopolitical basis. Thus, recently the European Bank for Reconstruction and Development (EBRD) stated that it could fund the construction of the last section of the pipeline in the north direction - to the Polish port of Gdansk. This statement brought about the severe reaction of Moscow as it takes to pieces the scheme, imposed by Russian oil giants - namely, the operation of the oil pipeline in reverse direction.

The Ukraine and some EU member-countries undertake intensive actions for the implementation of the Odessa - Brody - Plotsk project, accompanied with open criticism of its current operation in reverse (south) direction. The project in question envisages the transportation mainly of Caspian oil, thus bypassing Russia. Certain circles in Brussels also support the implementation of the project, trying to coordinate the actions of the countries involved. Thus, the Czech Republic and Slovakia, which until recently were quite skeptic about any transit and processing of light Caspian oil mostly because of the need for large investments and lack of guarantees for utilization of the pipeline's full capacity.

According to the President of the Ukrainian branch of the Russian oil concern "TNK - VR Ukraine", Alexander Gorodetsky, the project for extension of Odessa - Brody oil pipeline to the Polish city of Plotsk has a clear political coloring at the expense of the insufficient economic justification. He declares that : "Recently, we have been hearing a number of statements by high-level officials, and yet none from those who own the oil, i.e. the oil companies. Neither British Petroleum, nor Chevron has demonstrated any interest in the implementation of this project.

Apart from that, trends in the development of world oil market show that oil consumption in Europe will hardly increase especially in the near future and the expensive Caspian oil, delivered through the Odessa - Brody - Plotsk pipeline, is absolutely unnecessary for European oil refineries. Today the latter's needs are fully covered by the much more secure deliveries from Russia (Druzhba pipeline), the Near East, North Sea and Norway".

According to an analysis of the Polish state-owned oil company "Nafta Polska", the project for extension of Odessa - Brody pipeline to Plotsk will become economically expedient only when it has a daily capacity of at least 20 million tons of petrol. At the same time, the latest geological studies in the Caspian region show that oil reserves there are less than initially assumed.

Further to that, suppliers of Caspian oil, upon whom the Ukraine and Poland rely so much, have utterly different interests - they are mostly oriented to the markets of America, India and China, which guarantee maximum profits. Demand there is enormous and prices - much more attractive. Therefore, Caspian oil will be transported to these markets through Baku - Ceyhan pipeline, the Caspian pipeline consortium (CPC) and the new pipeline from Kazakhstan to China. Given such market environment, obviously it would be impossible to guarantee the additional transit of tens of millions tons of oil, necessary for the economic justification of the implementation of Odessa - Brody - Plotsk route.

In the present situation, when the volumes of Azeri oil is more than insufficient for the implementation of Odessa - Brody - Plotsk scheme, Kazakh oil is considered in the already elaborated business plan as the only actual resource. Still, the prospects for implementation of this plan look highly improbable. The main part of Kazakh oil resources will be directed to China through Atasu - Alashankou pipeline, which is expected to have annual transit capacity of 10 million tons of petrol, while at a later stage this capacity will increase to 20 million tons with the flows of Russian crude oil from Western Siberia, coming through Omsk - Pavlodar - Shimkent pipeline. Furthermore, Kazakh oil will most probably be used for the enhancement of CPC capacity to 67 million tons and will feed the future Bourgas - Alexandroupolis pipeline.

Astana considers Baku - Tbilisi - Ceyhan (BTC) pipeline as one of the possible routes for the transit of Kazakh oil (attractive as regards the enhancement of export potential), the designed capacity of which is 50 million tons per year. The US are particularly active in lobbying for the inclusion of Kazakhstan into the BTC because without Kazakh oil the pipeline could prove cost-ineffective. An evaluation of experts from the Georgian company "Naftatransa", hitherto Astana would be able (in the best scenario) to guarantee the annual shipment in Baku by sea of only 5 - 8 million tons which is highly insufficient for the utilization of the full capacity of Baku - Tbilisi - Ceyhan pipeline, let alone Odessa - Brody - Plotsk pipeline.

The consortium, established specifically for the implementation of Odessa - Brody - Plotsk project, is not in the position yet to present precise data on the benefits and profits from the project, under the excuse of the difficult identification of its true competitiveness. This is the reason why the necessary forecasts for the return-on-investment terms have not been prepared, which additionally hinders the attraction of investments. At the same time, some tentative calculations are being made on the basis of the assumption that the pipeline will carry 25 million tons of oil per year although the existing and designed oil stations can provide not more than 16 million tons per year.

Thus, Warsaw and Kiev, openly using political arguments, are trying to solve their own problems (guaranteeing additional financial means for themselves from oil transit and enhancement of their own positions in the eyes of Brussels "Eurocrats") at the expense of the other EU member-countries. The truth nevertheless is that not having concluded any guaranteed agreements with the oil suppliers, these two countries and the EU take the risk of being left with an "empty" pipeline, costing more than USD 500 million.

Meanwhile, in March 2005 Russia signed an agreement with Kazakhstan for launching the construction of the new extension of CPC pipeline - from Tengiz to Novorosiisk. This will allow a growth of 28 to 67 million tons of year of the transited oil through this pipeline. In result, the energy dependency of Europe and Turkey from Russia not only did not decrease (as Istanbul hoped during OSSE session in 1999, when the documents for the restriction of Russian maneuvers in post-Soviet space were signed) but it rather grew. Further to that, as the capacity of Turkish gas market is limited, the Trans-Caspian gas pipeline to Turkmenistan is becoming cost-ineffective, i.e. its construction brings no economic benefits.

In its desperate search for alternative (non-Russian) energy sources, Kiev sought contacts even with Tehran (although the latter has been branded by Washington as a part of the "axis of evil") to negotiate on the construction of a transit gas pipeline from Iran to Western Europe, bypassing Russia. In July 2005 even a Memorandum of understanding was signed between the Ukrainian NOU, Iranian Government and Gaz de France, and a month later started the preliminary talks on the project.

Undoubtedly, Iran is interested not only in the development of its own gas industry but also from acquiring Kiev (which is regarded with some benevolence in Europe) as its energy partner. Of course, the accomplishment of any positive result from Iranian - Ukrainian project in the near future seems highly problematic. Still, the Ukraine considers that cooperation with Iran in the energy sphere will bring additional revenues from gas transit and will, at the same time, enable it break free from Russian natural gas dependency. This task has become even more topical after the unsuccessful for Kiev talks with Moscow in August 2005 and the subsequent gas scandal at end-2005 and beginning of 2006 between Gazprom and NOU. As is well-known, in January 2006 Russia and the Ukraine reached agreement on natural gas prices, in result of which Kiev has already been paying double the price (i.e, USD 95 per 1000 cubic meters) to the mediator company "RosUkrEnergo".

Of course, this agreement would hardly put a stop to the Ukrainian - Russian gas dispute. Furthermore, the stability of shipments depend upon the unpredictable Turkmeni leader Saparmurat Niyazov, who hastened to make use of the heavy Russian - Ukrainian clash and raised the price of Turkmeni energy raw materials. Apart from that, after the meeting between Niyazov and high Russian and Ukrainian officials in the beginning of 2006, his country became a full member of all Russian - Ukrainian gas agreements and contracts, related to the conditions for export and transit of natural gas via the territory of the Ukraine. After all, Turkmenbashi, who is well aware of the serious dependency of Moscow and Kiev on Turkmeni gas, achieved a situation in which neither Russia, nor the Ukraine received from him any long-term price guarantees.

As regards the tricky partnership between Kiev and Tehran, hitherto it should be regarded mostly in the light of Ukrainian attempts at exercising pressure over Moscow. The West is concerned, though, that the implementation of Ukrainian - Iranian project would increase energy dependency of Europe on Iran, which in itself would erode opposition against the nuclear plans of the ayatollahs, thus weakening the motivation for their prevention. This project could give life to a new and probably significant funding source for the strategic nuclear program of Tehran, speeding up the construction of Iranian ballistic missiles with a large radius of action. On the other hand, Iran does not have a solid economic basis, at least not before it attracts the interests of sufficiently influential circles and companies in the West as was the case with Baku - Tbilisi - Ceyhan oil pipeline, where the geopolitical factor has obviously proven more important than the economic one.

The above-said confirms the new geopolitical role of the Ukraine as an American-European ally, who is assigned with significant auxiliary functions in the establishment of numerous alternative alliances (GUAM; the Organization for democratic development; Community of democratic choice) and in the launching of projects, aiming at the restriction of Russian regional influence.