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    Free Trade and Gas: Can Russia and Ukraine Really Integrate?

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    Russia-Ukraine Gas Conflict (292)
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    Russian and Ukrainian Presidents Vladimir Putin and Viktor Yanukovych met on Monday for the first time this year "to synchronize their watches" and discuss the prospects of bilateral relations, with energy issues topping the agenda.

    MOSCOW, March 5 (RIA Novosti, Vladislav Fedotkin) – Russian and Ukrainian Presidents Vladimir Putin and Viktor Yanukovych met on Monday for the first time this year "to synchronize their watches" and discuss the prospects of bilateral relations, with energy issues topping the agenda.

    Yanukovych came to Moscow for a working visit at Putin’s invitation, with Moscow clearly not abandoning attempts to achieve closer economic integration between the two ex-Soviet republics. Yanukovych’s talks in Moscow came shortly after his visit to Brussels on February 25, where EU officials urged Ukraine to make a choice between the post-Soviet customs bloc of Russia, Belarus and Kazakhstan and the possibility of a free trade deal with the EU.


    Ukraine, which has few energy resources of its own, relies heavily on gas imports from Russia. At the same time, Ukraine has been a major transit country for Russian gas supplies to Europe. Ukraine has been embroiled in several gas rows with Russia in the past few years over gas siphoning and gas prices, occasionally interrupting supplies to Europe, which gets around a quarter of its gas from Russia.

    In the latest row in early 2009, Russia halted all deliveries via Ukraine's pipeline system for two weeks after the two nations failed to agree a price for Russia’s gas deliveries to Ukraine.

    The gas deal eventually signed between Moscow and Kiev in 2009 tied the price for Russian gas to international oil prices, which have risen significantly since 2009, boosting Ukraine's bill. Former Prime Minister Yulia Tymoshenko is currently serving a seven-year jail sentence for exceeding her authority in signing that contract.

    The deal seemed to be advantageous for Ukraine at the time of signing, as the price of oil stayed around $75-80 a barrel, after touching $147 in July 2008 and plummeting to $47 when the global economy was deep in recession. Ukraine paid less than $300 per 1,000 cubic meters of Russian gas supplies in 2010, but that rose to above $300 in 2011 as world oil prices started to rise steadily. By 2012, Ukraine was already paying $400 per 1,000 cu m on average and the price of its Russian gas imports in 2013 has risen to $430 per 1,000 cu m.

    Weaker demand for steel, a key export commodity and a major source of revenue for Ukraine, and the country’s unsuccessful attempts to restart cooperation with the International Monetary Fund, which has demanded unpopular economic reforms in exchange for unfreezing its loan provisions to Kiev, are pushing Ukraine to cut a deal with Russia to reduce the burden of its burgeoning gas bill.

    Russia has said on numerous occasions it could cut gas prices for its neighbor, if Ukraine joins the Customs Union or cedes control of its gas pipeline network to Gazprom.


    At his meeting with Yanukovych, Putin outlined the benefits of Ukraine’s accession to the Customs Union. “As for Ukraine’s participation in the Customs Union, Ukrainian specialists believe that the country’s GDP will rise by 1.5-6.5 percent, if it joins the bloc. It depends on the extent of that integration,” he said.

    Yanukovych said Ukraine still needed to decide on the format for its participation in the Customs Union, and the issue was still a matter for debate in Ukraine’s politics.

    Ukraine has proclaimed a strategic course of Euro-integration and plans to sign an Association Agreement with the European Union in late 2013 which also promises to give a significant fillip to the Ukrainian economy.

    Kiev is reluctant to become a full member of the Moscow-led Customs Union, because such a deal would rule out signing a free trade agreement with the European Union. Kiev has proposed cooperating with the union under a "three plus one" format, an option that does not suit Moscow.


    Ukraine’s Soviet-era gas pipeline system, which until recently accounted for 80 percent of Russian natural gas supplies to Europe, is another factor that may nudge Russia and Ukraine toward a compromise.

    Gazprom has repeatedly indicated its interest in controlling Ukraine’s gas transportation system in exchange for lowering gas prices for Kiev.

    Back in the early 2000's, Kiev and Moscow discussed the possibility of creating a gas transport consortium with the involvement of European partners to manage and modernize Ukraine's dilapidated gas pipeline network.

    However, when West-leaning President Viktor Yushchenko came to power in Ukraine, the project was put on hold. The Ukrainian authorities said at the time that leasing out the gas transport network would jeopardize Ukraine’s sovereignty.

    Ukraine’s refusal to consider a gas consortium prompted Russia to launch the Nord Stream and South Stream gas pipeline projects to pump natural gas directly to European consumers, bypassing transit states.

    Russia has already completed Nord Stream’s two parallel pipelines along the Baltic Sea bed, which will pump 55 billion cu m of gas to Europe once they reach full capacity.

    On December 7, Gazprom launched construction of the South Stream gas pipeline, which will run along the Black Sea seabed and pump 63 billion cubic meters of natural gas to Europe each year. The launch of South Stream in early 2016 will radically weaken Ukraine’s gas transit leverage, as it will allow Russia to pump natural gas to Europe directly, bypassing the territory of its neighbor.

    Gazprom may still be interested in gaining control of the Ukrainian gas pipeline network to modernize it and ensure uninterrupted gas supplies to Europe where the demand for natural gas is likely to increase in coming years, as Gazprom forecasts.

    Recent media reports have said Ukraine may lease out its gas pipeline network to Russia. This option, however, is hardly likely to be acceptable for the Russian gas monopoly, which sees little reason for modernizing it without gaining the possibility of controlling it.

    The Monday working meeting between the Russian and Ukrainian presidents resulted in no new energy agreements or decisions about the Customs Union. Ukraine still seems to be content to continue making reassuring noises about economic integration to Russia and the EU in order to secure concessions from both.


    Russia-Ukraine Gas Conflict (292)
    European Union, gas, GDP, Viktor Yushchenko, Viktor Yanukovych, Vladimir Putin
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