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January 26, 2006

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Reference ID Created Released Classification Origin
06KIEV337 2006-01-26 08:14 2011-08-30 01:44 CONFIDENTIAL Embassy Kyiv
This record is a partial extract of the original cable. The full text of the original cable is not available.


C O N F I D E N T I A L SECTION 01 OF 03 KIEV 000337 


E.O. 12958: DECL: 01/25/2016 

REF: KIEV 280 

Classified By: Ambassador, reason 1.4 (b,d) 

1. (C) Summary:  In a January 19 meeting with Ambassador, 
Roman Bezsmertny, campaign chief for President Yushchenko's 
party People's Union Our Ukraine, spun the January 4 
Ukraine-Russia gas agreement as an advantageous deal for 
Ukraine.  On a macro level, the higher prices would force 
necessary restructuring on Ukrainian industry that the 
Government of Ukraine (GOU) would have had a hard time 
implementing on its own; Gazprom would serve as a convenient 
scapegoat.  Monopolies of any sort, including Naftohaz, were 
bad for the economy, and the creation of a joint venture 
between Naftohaz and RosUkrEnergo (RUE) was the first step in 
creating checks and balances in the gas sector.  Bezsmertny 
claimed the terms of the deal would give Ukraine an extra 20 
billion cubic meters of gas in payment for transit, which 
could be re-sold at market prices for further revenue gains. 
Pre-election politics prevented Yushchenko from plugging the 
deal along the lines of his analysis, he claimed.  Whether or 
not Bezsmertny's math adds up or his predictions come true, 
his take on the deal may help explain why Our Ukraine 
insiders do not see the January 4 deal as a catastrophe for 
Ukraine's national interests.  End summary. 

Crisis?  What gas crisis? 

2. (C) Wielding his trademark acid tongue, Yushchenko party 
campaign chief Roman Bezsmertny discussed with Ambassador 
January 19 the January 4 Ukraine-Russia natural gas deal. 
(Bezsmertny's comments on domestic political dynamics were 
reported reftel.)  Bezsmertny averred that there was no 
longer any crisis over gas.  The stand-off with Russia and 
the resulting agreement had been an opportunity to change 
public perceptions about who was responsible for gas pricing. 
 It also drove home the need to improve energy efficiency and 
restructure industrial input pricing.  Ukrainians did not 
seem aware prior to the crisis of the monopoly status 
Naftohaz enjoyed on gas distribution, Bezsmertny mused.  Nor 
did they realize that it was not the Government of Ukraine's 
responsibility to set the price of gas.  (Note:  On Ukraine's 
domestic market, gas prices are set by the National 
Electricity Regulating Commission.) 

Forcing industrial restructuring (and blaming Gazprom) 
--------------------------------------------- --------- 

3. (C) Bezsmertny said he had bluntly told leading 
industrialists, including Serhiy Taruta, oligarch boss of the 
Industrial Union of the Donbas (IUD), earlier on January 19: 
Don't blame Yushchenko for $95 gas.  The alternative was 
Gazprom's $230 gas, not the old $50 price.  Industrialists' 
complaints came as no surprise; businessmen were focused on 
the bottom line, and higher gas prices meant lower profits. 
However, Ukraine's industrialists had previously based their 
business plans on completely unrealistic input costs.  They 
needed to adjust; otherwise, competition from more efficient 
producers would crush them.  "I told Taruta he should 
capitalize on this opportunity, or expect to see Mittal 
(recent buyer of Ukraine's largest steel works) to become the 
steel monopolist for Ukraine," said Bezsmertny.  The five 
years of the agreement would serve as a transition period. 

4. (C) Bezsmertny claimed that, in terms of forcing the pace 
of restructuring, an interim price of $120, rather than $95 
would have been more effective.  There was no other mechanism 
available to the GOU to force change besides the price 
mechanism; both President Yushchenko and PM Yekhanurov 
understood this clearly.  The GOU needed to overhaul the 
price structure of utilities/communal services, combined with 
compensation for pensioners and other vulnerable segments of 
the population.  The genius of taking advantage of Gazprom's 
power play, noted Bezsmertny, was that the GOU could pin the 
blame for the pain of restructuring on Gazprom/the Kremlin, 
and facilitate change that the GOU by itself would not have 
been able to force onto industry. 

Turning off selected valves to force payment 

5. (C) Bezsmertny claimed that the New Year's showdown had 
played into Ukraine's hands in collecting tardy payments for 
gas supplies already taken but not yet paid for, as well as 
in managing industrialists' price expectations.  Drawing a 
rudimentary pipeline diagram, Bezsmertny said that there had 
been no New Year's Day drop in the pressure along the main 
pipeline, because the pressure had to remain the same at the 
Russian and Polish borders.  However, Naftohaz Chair Ivchenko 
"fulfilled his tasking perfectly" by temporarily cutting off 
supply to enterprises behind on payments.  They immediately 
paid up, and their gas was restored.  In the past, when 
Ukraine paid $50 for Turkmen gas at the Turkmen border, the 
price to internal Ukrainian enterprises was $160.  In their 
own minds, with a rise to $95 under the January 4 deal, 
industrialists feared the price of delivered gas would soar 
above $200, even if that would not be the case.  Ambassador 
asked why Naftohaz had not forced repayment ear
Bezsmertny again cited the "blame Moscow" opportunity to 
deflect blame away from Ukrainian authorities. 

Will $95 hold for five years?  No, but politics is politics 
--------------------------------------------- -------------- 

5. (C) Bezsmertny said that there was no implied obligation 
for the price of gas under the January 4 deal to stay at $95 
for five years and suggested no one should expect it to stay 
at $95.  That price was simply an orientation figure; the 
final price would depend on contracts.  Ambassador asked why 
Yushchenko and Energy and Fuels Minister Plachkov had said 
publicly that the price would remain the same.  Bezsmertny 
replied that Yushchenko understood the reality but had to 
manage expectations in the run-up to the March 26 elections. 
Bezsmertny accused a range of Ukrainian politicians of having 
meddled in the negotiations with Russia by traveling to 
Russia in December and meeting with Russian officials;  Party 
of Regions leader Yanukovych, Rada Speaker Lytvyn, and even 
ex-PM Tymoshenko in an unpublicized trip in the December 
26-28 timeframe, days before the New Year's gas crisis.  They 
had been a "fifth column" undermining Ukrainian national 

Who benefits from RosUkrEnergo and the contract? 
--------------------------------------------- --- 

6. (C) Ambassador emphasized our disquiet with RUE's role. 
The West had supported Yushchenko because we thought he 
represented something qualitatively new for Ukraine.  RUE 
epitomized the old nontransparent, corrupt way of doing 
business.  The U.S. understood that Ukraine felt it had to 
accept RUE's role to reach agreement with Russia.  But other 
elements of the January 4 deal also were disturbing, 
including the proposed joint venture.  It would be critical 
that the joint venture be transparent. 

7. (C) Ambassador asked Bezsmertny which Ukrainians benefited 
from RUE, and passed a list of surnames bandied about in the 
Kiev rumor mill:  (Petro) Yushchenko (the President's 
brother), Naftohaz chair Ivchenko, former senior presidential 
aide Tretyakov, and the brothers Vasyunnyk (deputy 
Presidential Chief of Staff Ivan and his brother, recently 
appointed to the Naftohaz board).  His balding pate 
reddening, Bezsmertny waved off the list and claimed reality 
was simpler, and driven from the Russian side, which accrued 
the real benefits from RUE and could set terms for the basis 
of a supply agreement.  Bezsmertny suggested Russian 
President Putin and the Russians benefiting from the new 
higher price would turn around and try to "buy Ukrainians" 
politically.  Bezsmertny claimed he had told Russian 
Ambassador to Ukraine (and ex-Gazprom Chair) Chernomyrdin 
that Ukraine would ignore whatever happened on the Russian 
side of the border in terms of management and payoffs.  The 
GOU task was to ensure no theft of resources occurred within 
Ukraine.  Returning to the list of alleged Ukrainian 
beneficiaries, Bezsmertny argued that if the list were 
accurate, Our Ukraine would have no problems financing a 
winning Rada campaign; it simply was not true.  (Note:  For 
Bezsmertny's political assessment, see reftel.) 

8. (C) Bezsmertny claimed that on December 29, the Russians 
had essentially proposed a $270-million bribe to Yushchenko 
to cut a deal on Russian terms; Yushchenko rejected it. 
Putin called back "within 20 minutes," offering a Russian 
loan to pay for the higher gas prices.  Yushchenko took 
offense, setting the stage for the January 1 showdown and the 
subsequent January 4 agreement. 

Joint Venture is good: will break monopolies, bring profits 
--------------------------------------------- -------------- 

9. (C) In contrast to the near universal condemnation of the 
proposed joint venture between Naftohaz and RosUkrEnergo 
(RUE) in the January 4 deal, Bezsmertny lauded the benefits 
Ukraine would accrue from its establishment.  He claimed that 
as a result of the changes in the agreement for gas and 
transit pricing, Ukraine would actually receive 20 billion 
cubic meters more under the new deal (50 billion as opposed 
to 30 billion in 2005).  That difference could be re-exported 
to Europe at the higher market price of $230, helping offset 
the higher cost of gas overall.  Ambassador asked Bezsmertny 
why GOU leaders did not advertise this supposed advantage. 
Bezsmertny replied in a cynical tone: "Because gas is all 
about theft and con games (vorovstvo i obman, in Russian), 
and manipulation of monopolistic advantage." 

10. (C) Bezsmertny claimed that the GOU needed to create 
competitive checks and balances within the Ukrainian gas 
system, because as long as all aspects of the gas system were 
under one roof at Naftohaz, monopolistic corruption and 
bribe-taking were inevitable.  The joint venture was only the 
first step to open up the sector.  There needed to be new 
actors like UkrHazDobichie (Ukrainian Gas Supply), 
UkrHazTransit (Ukrainian Gas Transit), and UkrHazProm 
(Ukrainian Gas Industry) and other spin-offs, whose 
self-interests could check each other, creating more of a 
market.  Bezsmertny emphasized that Yushchenko supported 
efforts to use market mechanisms; Tymoshenko's natural 
inclination was to use administrative measures or "London" 
(note:  a reference to gas trader Itera, with whom Tymoshenko 
is alleged to have enjoyed a close relationship). 

Fuzzy Math? 

11. (C) Comment:  As intriguing as Bezsmertny's macroeconomic 
rationale may appear in arguing why the January 4 deal was 
good for Ukraine, some of his numbers do not appear to add 
up.  If Ukraine received the $2.5 billion in transit fees 
Ivchenko has announced, it would be able to purchase about 26 
bcm at $95/tcm.  For Ukraine to get Bezsmerty's 50 bcm, 
Ukraine would have to negotiate a purchase price of $50/tcm. 
Party of Regions deputy Volodymyr Makeyenko, a former gas 
trader himself, predicted to us January 25 that the new price 
of gas delivered to Ukrainian enterprises would be about $120 
per thousand cubic meters.  While prices differ per type of 
user and rose throughout 2005, the average price for private 
industry previously was roughly $75/tcm plus transport, not 
$160 as Bezsmertny claimed. 

12. (U) Visit Embassy Kiev's classified website at 





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