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06KIEV3933, UKRAINE: Rada Reviews Natural Gas Sector; Allows Price Rise

October 13, 2006

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Reference ID Created Released Classification Origin
06KIEV3933 2006-10-13 11:45 2011-08-30 01:44 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Kyiv


DE RUEHKV #3933/01 2861145
R 131145Z OCT 06

E.O. 12958: DECL: NA 
SUBJECT: UKRAINE: Rada Reviews Natural Gas Sector; Allows Price Rise 
for Households 
Ref: KIEV 3758 
Sensitive but Unclassified. Not for Internet Distribution. 
1.  (SBU) Summary.  The Verkhovna Rada (parliament) reviewed on 
October 4 the preliminary results of its investigatory commission on 
NaftoHaz and the natural gas sector.  The commission reported 
multiple instances of mismanagement, malfeasance, and possible 
criminal acts within state-owned oil and gas monopolist NaftoHaz in 
2005-6, and made recommendations to regulate more rigorously the 
industry and the monopolist.  On October 5 the Rada reversed its 
vote of a week prior which canceled the huge price rises authorized 
since July.  Rada members were persuaded to reverse themselves after 
Deputy Prime Minister Kluyev promised to reduce the price by 18% 
from the July level and institute tiered pricing based on 
consumption.   Regional governments will therefore be able to charge 
$68/tcm for gas this winter, 94% higher than last year.   Consumers 
remain strongly opposed to the increases and many say they cannot 
afford them.  The GOU's maneuvering underscored the reality of 
higher energy prices for Ukraine and may have shifted blame for the 
higher prices from the Yanukovych government to its predecessors, 
while scoring a few populist points with the 18% price reduction. 
End Summary. 
Commission Finding: 
Poor NaftoHaz Management, Questionable Contracts 
--------------------------------------------- --- 
2.  (U) The Verkhovna Rada's Temporary Investigative Commission on 
the Gas Sector reported on October 4 its preliminary results at a 
Rada plenary session and promised full results by December 30. 
Commission Chairman and Socialist MP Andriy Derkach announced that 
the GOU had lost control of the gas sector in 2005, and that 
"incomprehensible and unprofessional" NaftoHaz negotiating positions 
had led to the significant rise in gas prices in January 2006. 
Derkach noted that evidence of possible malfeasance and other 
illegal acts had been uncovered and directed to law enforcement for 
3.  (SBU) The commission found the following reasons for NaftoHaz's 
worsened financial state: a decrease in profits due to the 2005 halt 
in gas re-exports; a sharp decline in payment discipline; a mistaken 
NaftoHaz policy of covering working capital deficits with foreign 
loans; and significant increases in non-production and management 
expenses.  (Comment: Oddly, the Derkach Commission did not list as a 
reason the reduced revenue that followed NaftoHaz's loss of 
higher-paying industrial customers to the NaftoHaz-RosUkrEnergo 
joint venture UkrHazEnergo.) The commission found violations and 
possible criminal offenses in NaftoHaz's foreign operations and 
financial management.  The majority of contracts for the supply of 
gas to Ukraine and its transit through Ukraine, according to the 
Commission, were signed in a non-transparent manner with significant 
procedural violations. 
Commission Finding: 
GOU Can Reduce Residential Gas Price 30% 
4. (U) The commission found that, based on cost data supplied by 
Ukrainian gas producers, the GOU could reduce the residential price 
of gas by 30% from the July 1 level of 414 UAH/tcm.  To protect 
vulnerable populations from rising gas prices, the Commission 
recommended establishing a working group to create a new system of 
subsidies for the 2008 budget.   The Commission recommended that all 
NaftoHaz profits from export, re-export, and transit of gas within 
Ukraine fund energy price subsidies.  (Note: Post is unaware of any 
current export or re-export of NaftoHaz gas and Gazprom recently 
reduced its planned 2007 sales volume to NaftoHaz, thus apparently 
eliminating a portion that could have been re-exported.)  The 
Commission also suggested that the NERC cancel UkrNafta and 
ChornoMorNaftoHaz's licenses to sell gas at unregulated rates, since 
according to Ukrainian legislation these state companies should be 
providing gas to residences at regulated rates. 
Commission Recommendation: 
Trust No One; Regulate Everyone 
5. (SBU) The Commission preliminarily recommended greater government 
oversight for the sector and for NaftoHaz, to include 
-- The National Electricity Regulatory Commission (NERC) and 
government ministries should verify NaftoHaz rate change 
-- A special commission from Ukraine's Accounting Chamber should 
review NaftoHaz gas procurements to ensure the company is purchasing 
the lowest priced gas. 
-- The Ministry of Fuels and Energy should develop a system to 
review NaftoHaz contracts and agreements before NaftoHaz signs them. 
-- The Ministry of Labor should develop a salary matrix for energy 
sector employees, with bonuses or higher salaries only to be paid 
from company net profits. 
-- The Ministry of Fuels and Energy should ensure the sector
international accounting standards. 
-- The Cabinet of Ministers should simplify the organizational 
structure of NaftoHaz. 
-- Employment decisions should be based on professional ability, and 
the Commission recommended reviewing the credentials of current 
members of Boards of Directors and Supervisory Councils of Ukraine's 
energy sector state companies, including NaftoHaz and its 
Rada Flip Flops on Gas Rate Rollback 
6.  (U) Following the investigatory commission's report, the Rada 
voted on October 5 to invalidate its over-ride of a presidential 
veto of September 22, which had rolled back gas prices to January 1 
levels and imposed a moratorium on future increases (reftel).  The 
October 5 decision was supported by 249 of 436 deputies.  Party of 
Regions, Socialist, and Communist deputies who initially supported 
the rollback now voted to overturn it, while Our Ukraine deputies 
who originally opposed the rollback voted to keep it in place.  Only 
Yuliya Tymoshenko Block deputies showed consistency in the two 
votes, being for the rollback in both instances. 
7. (SBU) A major reason for the Rada's reversal on gas prices was a 
change in the Yanukovych's government's position on gas prices:  the 
Cabinet of Ministers asked the Rada to reverse itself, despite the 
fact that the majority of ruling coalition MPs had voted for it. 
Prime Minister Yanukovych said it was too early to lower gas prices, 
noting that he was not yet confident it would be a "responsible 
step."  The parliamentary flip flop came after Deputy Prime Minister 
Klyuev promised  to introduce a range of compromise measures, 
including an 18% reduction in the residential gas price (to 339 
UAH/tcm) and a system of tiered pricing based on a family's monthly 
usage and floor space.  Communist Party leader Pyotr Symonenko 
pointed to the 18% rate reduction specifically in explaining his 
party's vote switch.  (Note: Boyko later announced the 18% reduction 
had been enacted, effective immediately, after an October 11 CabMin 
meeting. The tiered pricing Boyko said would begin November 1.) 
Local Governments Prepare for Winter Price Rise 
--------------------------------------------- -- 
8.  (U) Across Ukraine, regional governors are preparing their 
electorates for higher gas prices, which must be set at the local 
level to coincide with the NERC's increased wholesale price (339 
UAH/tcm) for regional distributors.  Governors in Zaporizha, Kiev 
Oblast, Lviv, Odesa and Poltava, as well as Kiev Mayor 
Chervonitskiy, have spoken out on the need for higher, economically 
justified rates.  Zaporizha, Kherson, Sevastapol, Lviv, 
Ivano-Frankivsk, Lutsk and Odesa have already raised rates, while 
Sumy, Luhansk and Karkhiv plan to do so soon.  Other major cities 
have put off the unpopular decision until the last possible moment. 
9.  (U) Chernovitskiy's Kiev City Administration published a draft 
resolution on October 10 to triple residential heating and hot water 
rates.  Residents would pay 2.03 UAH/m2/month for heat (up from 0.80 
UAH) and 10.72 UAH/m3 for hot water (up from 3.72 UAH).  For an 
average-sized apartment of 50 m2, a household's monthly heating bill 
would rise from 40 UAH ($8) to 101.5 UAH ($20), though Klyuev's 
price-tier plan, which includes a 20% reduction for families with 
household sizes of less than 100 m2, would reduce this payment to 
$16/month.  (Note: Ukraine's minimum wage currently is 375 UAH/month 
($75), while pensions are 366 UAH/month ($73); a $16 monthly heat 
payment is over 20% of a pensioner's income.) 
10.  (U) A September 15-20 Razumkov Center poll found that 72% of 
respondents thought high residential gas prices were not justified. 
48.5% of respondents blamed the government for the rise in prices, 
while 19.1% blamed President Yushchenko and 6.7% blamed local 
government.  14.4% answered that no one was to blame since the 
prices were based on higher gas prices from Russia.  Among 
respondents who already are paying higher gas prices, 31.3% 
responded that their families could not pay the new rates, and 56.9% 
answered that they could pay, but it would be difficult.  Only 5.5% 
said the higher prices would not cause budget problems.  (Note: 
Until the May and July increases, the GOU had not raised residential 
gas prices since 1999, aside from increases to cover overall 
11.  (SBU) The September gas price rollback vote created a minor 
firestorm in the Ukrainian press and served as a platform to 
highlight the preliminary findings of the Rada's investigatory 
commission on the gas sector.  The commission's recommendations were 
heavy on regulatory oversight and allocations, light on transparency 
and bringing modern management to NaftoHaz, and silent on 
introducing competition to the sector, which would likely be the 
only way to effect real reform and growth.  The media scrutiny 
highlighted the reality of higher gas prices, with one sound-bite 
noting that until recent increases Ukraine was behind only 
Turkmenistan in having the lowest residential gas prices in the CIS, 
and in Turkmenistan gas for households was free.  While the increase 
brings residential gas rates here closer to international levels, 
they remain below wholesale prices for imported gas.  Some in the 
GOU like to argue that they are not selling gas to households at a 
loss because cheaper domestically-produced gas is "dedicated" to 
household customers.  However, this in turn leads the GOU to depress 
prices at domestic well-heads, removing an incentive for greater 
domestic gas production.  The commission and media attention may 
have shifted blame from the sitting Yanukovych government to the 
previous one, but regardless of who is in the CabMin, increased 
energy prices will be a bitter pill for Ukraine's most vulnerable 


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