Russia Props Up a Controversial Figure in Ukraine's Energy Industry

Summary

With a key decision on Ukraine's orientation toward Europe approaching, the Russian government continues to apply pressure on Kiev. Unnamed sources within Gazprom said Oct. 9 that the Russian energy giant would supply natural gas at a discounted rate to Ostchem Holding, a firm run by influential Ukrainian oligarch Dmytro Firtash. Under the deal, Ostchem would purchase 5 billion cubic meters of natural gas for storage purposes, discounted at 30-36 percent, or to around $260 per thousand cubic meters.

Key to the announcement is the exclusion of Ukrainian state energy firm Naftogaz, which has been embroiled in a yearslong dispute with Gazprom over energy supplies and pricing. Neither Gazprom nor Ostchem has confirmed the deal, but if true, it would give a significant boost to the controversial Firtash, who has previously challenged the Ukrainian government in favor of Russian interests.

Analysis

Firtash was previously the chairman of RosUkrEnergo, an intermediary that oversaw Russia's natural gas exports to the Ukrainian market. In 2009, Firtash was accused by then-Ukrainian Prime Minister Yulia Timoshenko of taking advantage of his position and embezzling and siphoning off natural gas, and his company was sued and stripped of its intermediary status. The same year, Timoshenko concluded a new natural gas deal with Russia that no longer included RosUkrEnergo as a party to the contract.

The deal that Timoshenko inked has been the source of significant controversy in Ukraine. Signed in the midst of a natural gas cutoff, the pricing and conditions have been seen as extremely unfavorable to the Ukrainian side. When Timoshenko's rival, Viktor Yanukovich, defeated her in her bid for the presidency in 2010, one of his first acts was to imprison Timoshenko for "abuse of power," specifically referring to her signing of the natural gas contract with Russia. Yanukovich also sought to revise the contract; the price was tied to oil prices and has risen steadily over the past few years to more than $400 per thousand cubic meters, one of the highest among the Commonwealth of Independent States.

The pricing dispute has remained a dominant feature of Ukrainian-Russian relations for years. Russia has said it would provide Naftogaz with lower prices only if Ukraine joins Russia's Customs Union and if Russia can increase its stakes in Ukraine's energy industry, preferably in a merger between Naftogaz and Gazprom. Yanukovich has so far refused, knowing that such outcomes would significantly undermine the sovereignty of the country in the long term, despite offering short-term price breaks and a financial reprieve to the economically struggling country.

Instead, Yanukovich has pursued further integration with the European Union and has sought to get Brussels involved in any sort of restructuring of Ukraine's energy industry and regulations. This has unnerved Russia, which responsed to Ukraine's move to sign free trade and association agreements with the European Union in November with trade restrictions. Kiev has not yet reversed its course, so Moscow has been ramping up the pressure on the energy front. Its support for Firtash has been growing over the past few months -- Russia increased natural gas exports to Firtash's group, which oversees much of Ukraine's industrial and chemical industry -- while Naftogaz has been decreasing imports from Gazprom and searching for alternative suppliers.

The latest announcement regarding a significant price discount for Ostchem is thus significant for two reasons. First, it contrasts starkly with deadlocked pricing negotiations between Gazprom and Naftogaz and reveals a Russian strategy to resurrect its own allies in Ukraine if the current leadership continues to resist. Second, it will allow for the pumping of natural gas into underground Ukrainian storage facilities, which are crucial to ensure the flow of energy during the winter period. This means that European countries further downstream -- countries that distinctly remember being cut off as a result of previous disputes between Ukraine and Russia -- will have an adequate supply of natural gas and are unlikely to see major disruptions in the coming winter. But in the meantime, Ukraine and Russia will be more entrenched in their dispute over what the future of their energy relationship should look like.

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