Pipelines and Petropolitics in Ukraine

On April 26, 2006, the Carnegie Endowment for International Peace hosted a meeting entitled “Pipelines and Petropolitics” with Oleksandr Todiychuk, Chairman of the Board of UkrTransNafta. Andrew Kuchins, Director of the Carnegie Russian and Eurasian Program, chaired the session.

I am pleased to see renewed American interest in Ukrainian energy. Today there are some American projects in Ukraine, for example on the shelves of the Black and Azov Seas. Vanko International recently won the tender to develop a field on the Kerch peninsula. There was some discussion of this tender in the press, but the company had serious documentation.

We would be glad to see more international companies in Ukraine. There are some bills now in the Rada that would protect foreign direct investment, particularly in oil and gas. American companies would still like some things to change, but they agree the climate has improved in recent years.

On the other hand, the Russian energy strategy is clear. Russia is seeking export routes that avoid Central Europe: to the Black Sea, to the Baltic, and to China. There is an unofficial Russian oil deficit in Europe. President Vladimir Putin confirmed this in Prague, when he said Russia receives the least revenue on oil delivered via the Druzhba pipeline. So it has created a deficit to increase the price.

Russia does not have enough oil. Its internal consumption rose 15 percent last year. The agricultural and defense sectors are major users, and automotive use has seen the fastest growth.

Despite this shortfall, Russia is trying to get a piece of the Chinese market. In one week they will initiate the “five plus five” project, shipping five million tons of Russian oil and five million tons of Kazakh oil to China. By 2010 this will be a “ten plus ten” project. Russia is also discussing a new pipeline, with an annual capacity of 20 to 30 million tons, around Lake Baikal to China. Putin made it clear he is personally supervising this project.

These tendencies show Central Europe that the deficit and high prices may continue, so Odessa-Brody and other projects are very important. Russia is afraid of losing this market, so it is buying Central Asian gas and reselling it in Europe. State-owned Russian companies are also buying transport infrastructure.

Ukraine is in difficult situation with Turkmen gas. So it is looking to the Nabuko project and gas swaps with the Balkans. Conflicts between Russia and the EU, and the United States and China, make it hard for Odessa-Brody to succeed. But there are new possibilities from the Caspian and the Arab world, so Odessa-Brody has a future.

Ukraine recently outlined its energy strategy to 2030. The first draft has attracted criticism, but it is better than nothing. Ukraine must unite with countries and companies that have similar strategies, as it hasn’t achieved its goals alone. Our Polish colleagues refer to this prospective bloc as a “new NATO” or “new OPEC,” saying that transit countries must work to counter Russian actions. For example, Russia has a special relationship with Germany and some other countries. The G8 must assess this and react. The US can use its influence in Poland, Ukraine, and the Caspian. American companies are interested in Odessa-Brody. They know how much they could make from the project, but worry about how much they could lose by displeasing Russia.

Lately there has been a problem with Russia: it doesn’t honor contracts. I don’t wish to be anti-Russian, however Russia has recalled its signature from agreements and cut the flow of the North Druzhba pipeline to the Ventspils refinery without warning. This behavior has created a lot of interest in alternative projects and fears of new winter surprises. Ukraine is preparing to work with Azerbaijan. President Ilham Aliyev’s visit to Washington must have gone well, because since his return Azerbaijan has proposed new projects with Ukraine. I don’t know the exact reasons, but I am pleased.

Q&A

Q: If no foreign companies have the courage to send oil through Odessa-Brody, could the Kazakh government or [state energy company] KazMunaiGaz do it?
A: Kazakhstan has options to China and to the south, but it still wants a presence on the European market. The country is in an interesting position. Officially they’re with Russia, but they do what they want. For Nazarbayev the election is now past and he has new prospects. He could work with the EU and he probably will. The US and the EU aren’t happy with oil and gas going to China, a large competitor on world markets. The reversal of Odessa-Brody forced Kazakhstan to build its China pipeline.
Some politicians say we can fill Odessa-Brody with 20 million tons from Kazakhstan and 20 million tons from Azerbaijan. But we will start with 2-4 million from Kazakhstan, 2 million from Azerbaijan, and 2-5 million from Batumi (in Georgia). These sources give Odessa-Brody a future. The first stage will take four to five years. Ukraine’s main strategy is conservation. Experts say Ukraine can cut consumption by 14-20 bcm per year. (Currently internal consumption is 80 bcm per year.) Ukraine wants to increase domestic production, especially offshore, and to do this it must create good conditions for Western companies. We will build metering stations on the borders as part of an agreement with the EU. This will allow Ukraine to fulfill its obligations to Russia and do swaps. Ukraine will also build underground storage.

Q: What can Ukraine do in the next 12-18 months to show it won’t get run over/passed by on energy? What is the strategy to get the right legislation through? Back in 1998 companies said they could bump up domestic gas and oil production significantly using new technology, but it hasn’t happened.
A: Before there big clans ruling, but now power is divided and we hope the picture will change. There are presidential and parliamentary elections. It is now more dangerous to engage in corruption. The Kryvorizhstal price difference [between the $800 million originally paid by former President Kuchma’s son-in-law, Viktor Pinchuk, and the $4.8 billion paid by steel magnate Lakshmi Mittal in a re-privatization auction] and the RosUkrEnergo deal show there are problems, but through their exposure we are progressing. People in Houston agree they see positive signs. If Western companies don’t just stand and watch, but participate in Ukraine, the process of improvement will continue. Experts from companies have helped in the shelf tenders and with some legislation. Before the Rada only wanted to make money. But now competition among clans will force the government to work more openly. The US got involved in democratizing a complicated country like Iraq, but it’s reluctant to get involved in Ukraine where the process would be easier.

Q: How should Ukraine deal with Russian investment?
A: We want conditions where Russian and non-Russian companies can participate on equal terms. Previously the rules favored Russian companies. So 80 percent of refining capacity in Ukraine is owned by Russia, but it isn’t operating. Instead the owners sell products processed elsewhere in Ukraine. We would like balanced participation.

Summary prepared by Matthew Gibson, Junior Fellow with the Russian and Eurasian Program at the Carnegie Endowment for International Peace.