08KYIV2358, UKRAINE’S DEPENDENCE ON RUSSIAN ENERGY

WikiLeaks Link

To understand the justification used for the classification of each cable, please use this WikiSource article as reference.

Discussing cables
If you find meaningful or important information in a cable, please link directly to its unique reference number. Linking to a specific paragraph in the body of a cable is also possible by copying the appropriate link (to be found at theparagraph symbol).Please mark messages for social networking services like Twitter with the hash tags #cablegate and a hash containing the reference ID e.g. #08KYIV2358.

Reference ID	Created	Released	Classification	Origin
08KYIV2358	2008-12-02 13:16	2011-08-30 01:44	CONFIDENTIAL	Embassy Kyiv

VZCZCXYZ0000
RR RUEHWEB

DE RUEHKV #2358/01 3371316
ZNY CCCCC ZZH
R 021316Z DEC 08
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC 6831
INFO RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RHMFISS/DEPT OF ENERGY WASHINGTON DC

C O N F I D E N T I A L KYIV 002358 
 
SIPDIS 
 
DEPT FOR EUR/UMB, 
EEB/ESC/IEC FOR SGALLOGLY AND LWRIGHT 
DOE FOR LEKIMOFF, CCALIENDO, RBOUDREAU 
DOE FOR NNSA: NCARLSON, CHUNSAKER, TKOONTZ 
USDOC FOR 4231/ITA/OEENIS/NISD/CLUCYK 
 
E.O. 12958: DECL: 12/02/2018 
TAGS: EINV ENRG EPET PINR PREL UP
SUBJECT: UKRAINE'S DEPENDENCE ON RUSSIAN ENERGY 
 
REF: A. KYIV 2113 
     ¶B. KYIV 2008 
     ¶C. KYIV 1950 
     ¶D. KYIV 1219 
 
Classified By: Acting Economic Counselor William Klein for reasons 
1.4 (b) and (d) 
 
¶1.  (C) Summary.  The ongoing gas price discussions for 2009 once 
again highlight Ukraine's strong dependence on energy imports from 
Russia:  Ukraine depends on Russia for 80 percent of its natural gas, 
61 percent of its oil, 100 percent of its nuclear fuel, and for the 
disposal of all the fuel it burns in its nuclear power plants.  This 
near total dependence on Russia has left Ukraine little negotiating 
room with its northern neighbor.  Successive governments have 
acknowledged that Ukraine can reduce this dependence by developing 
domestic resources and improving the energy efficiency of Ukraine's 
wasteful economy. Ukraine possesses significant untapped gas and oil 
reserves, and the country is making slow and halting progress towards 
reducing dependence on Russia in the civil nuclear sector.  However, 
a lack of political will, shortsightedness, bad policies, a shortage 
of capital and distrust of foreign investment, combined with a 
negotiating partner that has proven to be far savvier than its 
Ukrainian counterparts, have prevented Ukraine from reducing its 
dependence on Russia.  To diversify sources of energy and reduce its 
dependence on Russia, Ukraine will need to improve energy efficiency, 
eliminate corruption, boost transparency, and open the sector to 
foreign investment, during increased political uncertainty in Kyiv. 
End summary. 
 
Natural Gas: 80 percent from Russia 
----------------------------------- 
 
¶2. (SBU) Currently, Ukraine is dependent upon Russia for 80 percent 
of its gas.  Nominally, the majority of this gas comes from Central 
Asia, yet Russia has full control over all gas sold to Ukraine from 
the East.  Until 2006, Ukraine was confident that its strategic 
position as the chief conduit of Russian gas to Western Europe would 
guarantee it cheap prices indefinitely.  Things changed drastically 
when Russia actually cut off gas to Ukraine for two days, however. 
 
¶3. (SBU) Gas prices have increased from $50/tcm in 2005 to $179/tcm 
this year, and both Russia and Ukraine agree that Ukraine will soon 
need to pay roughly Western European prices for its imports.  An 
October 2 Memorandum of Understanding between Russian Prime Minister 
Putin and Prime Minister Tymoshenko foresees a long-term contract 
that will gradually bring Ukraine closer to market prices over the 
next three years while eliminating the infamous gas middleman 
RosUkrEnergo (RUE). (Note: Naftohaz Chairman Oleh Dubyna explained in 
the press that a long-term contract means a contract valid until 
¶2019.  End note.) 
 
¶4. (SBU) Ukraine has failed to use its gas pipeline and storage 
system to its full advantage in its dealings with Russia.  Ukraine is 
the world's largest transit country for natural gas, transporting 
110-120 billion cubic meters (bcm) of gas to Western Europe every 
year.  Although volumes continue to rise, Gazprom pipeline projects 
Nordstream and South Stream will reduce Russian dependence on the 
Ukrainian transit pipeline and further weaken any hope for Ukraine 
that it could use its pipeline to its negotiating advantage.  In 
addition, Moscow in recent years concluded long-term contracts with 
Central Asian producers that permit only Russia to buy most of 
Central Asia's gas, blocking any efforts on Ukraine's part to bypass 
Gazprom by 
purchasing Central Asian gas directly. 
 
¶5. (SBU) It would seem logical that, in return for paying market 
prices for gas, Ukraine could charge Russia market prices for transit 
and storage.  Currently Ukraine charges Gazprom 
$1.70/tcm/100 km in transit fees, while the EU average transit rate 
in 2007 was $7.04/tcm/100 km, or four times higher.  Ukraine also 
receives only $2.25/tcm for gas storage, while Hungary earned $25/tcm 
in 2007.  Although many Ukrainian officials have said that Ukraine 
needs to renegotiate both gas transit and storage fees, the 2004 
agreements prohibit the GOU from doing so until 2029. 
 
The Alternative: Developing Domestic Gas Reserves 
--------------------------------------------- ---- 
 
¶6. (SBU) Ukraine could reduce dependence on Russian gas imports by 
developing the large gas reserves in the Black Sea and in the 
interior of the country.  Ukrainian geologists estimate that with the 
proper technology and investment Ukraine has enough gas to meet 
domestic consumption for hundreds of years.  However, various 
governments have repeatedly thwarted development of these resources 
with bad policies.  Severe caps on the sale price for domestically
 
produced gas have discouraged production and exploration and led to 
led to a grey market that has furthered corruption in the already 
non-transparent gas sector.  The Tymoshenko government's unilateral 
abrogation of the Production Sharing Agreement with Houston-based 
Vanco will freeze development in the Black Sea until the dispute is 
resolved.  The government's action is also acting as a strong 
deterrent on foreign investors' willingness to commit to the 
large-scale, long-term type of capital investments that domestic 
exploration requires. 
 
¶7. (SBU) Ukrainian energy experts estimate that as much as 3.5 
trillion cubic meters of coal methane could be captured, which could 
boost domestic gas production by 40 percent.  So far, however, the 
GOU has failed to take any steps to exploit coal mine, coal bed, or 
abandoned coal mine methane capture.  For years, U.S. and other 
foreign companies have expressed interest in developing methane 
capture projects, but have received little or no interest from the 
GOU or Naftohaz.  Both insist that subsidiaries of Naftohaz 
eventually will have the financial and technical capability to 
capture methane themselves.  Ukraine also is unwilling to pay for 
costly pipelines and additional storage facilities that would be 
needed for methane capture.  Despite Naftohaz's official line against 
foreign investment, some company contacts have told us that barring 
an influx of much-needed foreign investment and technical know-how, 
methane most likely will remain underground, making coal mines more 
dangerous while polluting the environment further. 
 
Dependence on Russian Oil 
------------------------- 
 
¶8. (SBU) Oil is imported primarily for producing gasoline and diesel 
fuel, with 61 percent from Russia and the remainder produced 
domestically.  Ukraine imports 70 percent of its gasoline and diesel, 
not from Russia, but from Romania, Belarus, and Lithuania. 
Nonetheless, Ukraine's main suppliers of gasoline are of course 
dependent on crude oil imports from Russia, giving Russia additional 
influence on Ukraine's gasoline and diesel supplies.  Moreover, 
gasoline imports from Russia could rise significantly if Russia makes 
good on talk of reducing export tariffs for refined gasoline. 
 
¶9. (SBU) Of the six oil refineries in Ukraine, Russian companies own 
the Lysychansk refinery in eastern Ukraine (TNK-BP), the Odesa Oil 
Refinery (Luk Oil), while the Tartarstan Republic (part of the 
Russian Federation) and the Russian company Tatneft are battling for 
legal control of the Kremenchug Refinery in Central Ukraine.  Ukraine 
is also an important transit country for Russian oil exports to 
Western Europe, having transported 26 million tons (Mt) through the 
Druzhba pipeline and another 14 Mt through the Prydniprovski pipeline 
in 2007. 
 
Alternatives to Russian Oil 
--------------------------- 
 
¶10. (C) Ukraine could reduce its dependence on Russian oil by further 
developing onshore resources and by tapping the reserves of the Black 
Sea.  However, as with the case with gas, developing the oil 
resources of the Black Sea will make little progress until the PSA 
dispute with Vanco is solved (ref D). 
 
¶11. (C) The Odesa-Brody pipeline is Ukraine's most manifest attempt 
to reduce dependence on Russian crude oil.  Ukraine has always hoped 
to pump Caspian crude from Odesa to Brody, a town in western Ukraine 
that is linked to the Druzbha pipeline.  The pipeline was completed 
in 2002 under President Kuchma.  Both Kuchma and successive 
governments believed that business would surface once the pipeline 
was built, despite repeated advice by foreign experts that the 
project lacked a sound commercial underpinning.  (Comment:  Some 
observers argue that the project was primarily conceived as a cash 
cow for Interpipe, the pipe producer owned by Kuchma son-in-law 
Victor Pinchuk.  End comment.)  The pipeline remained empty until 
2004 when TNK-BP and Transneft concluded a contract with the GOU to 
transport Urals crude in the opposite direction, from Brody south to 
Odesa. In 2007, TNK-BP shipped more than 9 Mt of Russian oil through 
the pipeline. 
 
¶12. (SBU) President Yushchenko has revived efforts to re-reverse 
Odesa-Brody with the hope of off-taking a percentage of oil to be 
refined at the Nadvirna and Drogobych refineries in western Ukraine. 
In order to achieve Yushchenko's goal, Ukraine would need to 
reconfigure an existing refinery to refine Caspian crude or invest in 
the construction of a new refinery, which could cost up to $4 
billion.  Yushchenko also aims to transport Caspian crude northward 
 
via the pipeline to Europe.  So far, Ukraine and potential partners 
Poland, Azerbaijan, Lithuania, and Georgia have failed to reach an 
agreement that would provide adequate supplies of Caspian oil needed 
to secure the re-reversal of Odesa-Brody. 
 
Dependence in the Civil Nuclear Sector 
-------------------------------------- 
 
¶13. (C) Little attention has been paid to Ukraine's complete 
dependence on Russia for its nuclear fuel supplies.  Ukraine's state 
nuclear energy generating company, Energoatom, currently buys all of 
its nuclear fuel from the Russian state-owned company TVEL via 
long-term contracts that require annual price negotiations, similar 
to the arrangements for natural gas. Ukraine's 15 nuclear reactors 
generate 50 percent of the country's electricity; a disruption of 
nuclear fuel supplies and continued lack of domestic spent fuel 
management infrastructure could be catastrophic for Ukraine.  Ukraine 
Energy expert Frank Lemkey told us that most Ukrainian politicians 
are so concerned about natural gas supplies that they fail to 
recognize Russia civil nuclear leverage. 
 
Alternatives to Russian Nuclear Fuel and Storage 
--------------------------------------------- --- 
 
¶14. (C) In an attempt to diversify its nuclear fuel supplies, 
Energoatom in 2008 signed a contract with Westinghouse to provide 
nuclear fuel for three of Ukraine's reactors beginning in 2011, which 
would cover 20 percent of Ukraine's nuclear fuel needs.  Westinghouse 
has reported that TVEL has attempted to thwart the Westinghouse deal 
and any future deals by telling Ukrainian officials that Westinghouse 
fuel is 30 percent more expensive than TVEL's fuel and that 
Westinghouse has hoodwinked Kyiv.  Westinghouse representatives have 
countered that TVEL's last three annual negotiations with Energoatom 
have resulted in price increases for TVEL-provided fuel, which in the 
next few years would significantly close the price gap between 
Westinghouse and TVEL. 
 
¶15. (C) Westinghouse has offered to supply fuel to three additional 
Ukrainian reactors at a fixed price if Energoatom agrees to expand 
the existing contract by March 2009.  Westinghouse also is willing to 
transfer technology to Ukraine, provide a fuel fabrication facility, 
and engage with Ukrainian industry for the supply of some fuel &#x000A
;components.  However, there are reports that Ukraine may sign 
long-term contracts with TVEL for fuel supplies through 2025 and form 
partnerships with Russian companies to construct a fuel manufacturing 
facility. 
 
¶16. (C) Ukraine pays about $150 million in annual fees to Russia for 
storage and reprocessing of spent nuclear fuel.  Russia has 
significantly increased these fees during the past three years.  If 
Ukraine refused to accept terms and conditions dictated by Russia for 
spent fuel storage management, the lack of on-site and central 
storage facilities would choke half of the Ukrainian nuclear energy 
sector.  Although Ukraine's Energoatom signed a contract with U.S. 
company Holtec International in 2005 for the construction of a 
Central Spent Nuclear Fuel Storage Facility, progress on this project 
has been very slow and political obstacles continue to hinder the 
realization of this important facility. 
 
Little Done in Energy Efficiency, Alternative Fuels 
--------------------------------------------- ------ 
 
¶17. (U) Ukraine could also reduce its dependence on Russian energy 
imports by increasing energy efficiency.  Energy consumption per unit 
of GDP is among the highest in the world.  When consumption is 
measured in such terms, Ukraine uses twice as much energy as the EU, 
2.7 times as much as the USA, and 6.5 times as much as Japan. 
Private industry, and in particular the largest, export-oriented 
industries, have invested heavily in recent years to reduce their 
energy consumption.  At the same time, energy waste is particularly 
severe in the municipal heating sector, where the Soviet-era 
infrastructure has received little new investment since independence 
in 1991. 
 
¶18. (C) The GOU created the National Agency for Effective Use of 
Energy Resources (NAER) in December 2005 to boost energy efficiency. 
NAER Head Ihor Cherkashin told EconOff that the NAER has yet to gain 
sufficient support from the Parliament and other ministries. 
Cherkashin said that some ministries have taken the energy efficiency 
mission as their own responsibility and do not coordinate efforts 
through the NAER.  He added that the NAER has programs for increasing 
efficiency for municipal heating, water supply, natural gas, and 
industrial sectors such as steel production and food production, but 
little funding has been allocated to the NAER.  These programs have 
 
made little progress as a result. 
 
¶19. (SBU) Ukraine's vast agricultural potential could make it 
attractive location for the production of biofuels.  The idea of 
using food to make fuel is extremely controversial in Ukraine, 
however, and little has been done to develop biofuel projects 
(although significant rape seed production is exported to Western 
Europe for the production of biodiesel).  Biofuel legislation, which 
many Ukrainian experts say would need to include subsidies for 
farmers and biofuel producers, has yet to be passed by the Rada 
(parliament). 
 
¶20. (SBU) Hydropower, generated mostly through vast Soviet-era 
hydroelectric plants on the Dnipro River, accounts for about five 
percent of the country's power needs.  Although the potential in most 
of the country is now exhausted, experts believe that hydropower can 
be expanded successfully in the mountains of western Ukraine.   Wind 
and solar account for less than one tenth of a percent of electricity 
generation.  While various GOU officials have given lip service to 
the need to further develop renewable energy, few concrete steps are 
actually being taken. 
 
¶21. (C) Comment.  Ukraine has been considerably weakened by its 
current financial, economic, and political instability as it attempts 
to negotiate with Russia over gas prices and supplies.  Kyiv is not 
in position to drive a hard bargain with Gazprom for gas or with TVEL 
for nuclear fuel.  Ukraine's reliance on its position as Russia's 
largest transporter of natural gas to Europe has created a false 
sense of energy security.  Ukraine will need to improve energy 
efficiency, eliminate corruption, boost transparency, and open the 
sector to foreign investment if it hopes to diversify sources of 
energy and reduce dependency on Russia.  That will require a 
long-term vision and a strong political will, all of which are in 
short supply in the current political environment.  End comment. 
 
TAYLOR

Wikileaks