Gas in Exchange for Naval Base: a Boon to Ukraine’s Weak Economy

The scene at the Ukrainian Parliament when lawmakers ratified an agreement to extend the lease of Russia's Black Sea Fleet in Sevastopol

Moscow has agreed to lower the price of gas for Kyiv by one-third in exchange for extending the lease of the Sevastopol base for the Black Sea Fleet (BSF) by 25 years. The Ukrainian parliament ratified the agreement on April 27, despite protests by the opposition. Both the Russian and Ukrainian governments are happy with the outcome: while Moscow satisfied its geopolitical ambitions, Kyiv expects economic benefits without which the national economy could be jeopardized. While Prime Minister, Vladimir Putin, plays geopolitics, the former governor of the heavily industrialized Donetsk Region, President Viktor Yanukovych, conducts business.

The political outcome for Ukraine is debatable. The opposition cites Article 17 which forbids the stationing of any foreign military bases in Ukraine. However, they ignore Article 14 of the constitution’s transitional provisions which expressly allows the temporary stationing of foreign troops in the existing military bases. This article was drafted in 1996 purportedly to legalize the BSF in Sevastopol, which was confirmed by accords with Russia in 1997, according to which the BSF was allowed to stay until 2017. Yanukovych and Medvedev in Kharkiv on April 21 extended the validity of the 1997 accord by 25 years until 2042, which does not contradict any Ukrainian law.

Setting aside the controversial political aspects, the April 21 accords benefit the Ukrainian economy in the short term. The price of Russian gas for Ukraine will be lowered to around $230 per 1,000 cubic meters, from $330 in the second quarter of 2010. More precisely, the discount will equal 30 percent if the price of gas calculated according to the January 2009 contracts between Russia’s Gazprom and the Naftohaz Ukrainy national energy company falls under $333, and the discount will be flat at $100 (if the price calculated for each quarter according to the contract formula is higher than $333) (UNIAN, April 21, 23). Ukraine paid $228 on average throughout 2009, and the corresponding price for 2010 was expected to amount to $334 if Moscow did not offer any discount.

The discount applies to 30 billion cubic meters (bcm) of gas to be imported by Ukraine in 2010 and to 40 bcm to be imported from 2011-2019 (Ukrainska Pravda, April 22). Yanukovych and Putin agreed that the discount is tantamount to $40 billion in assistance from Russia over the next 10 years. Ukrainian Prime Minister, Mykola Azarov, estimated that this is more than the foreign investment received by Ukraine since independence in 1991 (ICTV, April 25). Ukraine will save $2 billion in 2010, according to the government’s calculations (Kommersant-Ukraine April 26).

The discount will be at the expense of Russian taxpayers, Putin said (Interfax, April 27). At the same time, Ukrainian taxpayers will benefit. Azarov said there was no need to increase domestic gas prices in order to narrow the deficit of Naftohaz, which in 2009 was estimated by the International Monetary Fund (IMF) at 2.5 percent of GDP (ICTV, April 25).

Before the April 21 accords, the IMF insisted that Ukraine should double its domestic gas prices. This would have impoverished households whose incomes shrank in 2009 when GDP plummeted by 15 percent. This also would have affected Ukraine’s main export industries (metals and chemicals) which heavily rely on gas. Azarov estimated that an increase in the Russian gas price to $330 would stop the national chemical industry while the metals industry would operate at a loss (UNIAN, April 6). The two industries contributed most to the 11 percent year-on-year industrial production growth posted in the first quarter of 2010 (www.ukrstat.gov.ua, April 15). Finally, the gas price discount should allow Ukraine to qualify for the resumption of IMF assistance. Ukraine received almost $11 billion from the IMF in 2008-2009 and it hopes to receive another $20 billion according to a new two and a half year program which the cabinet wants to sign with the IMF (Ekonomicheskie Izvestia, April 26).

Of course not everything is positive. Long-term economic benefits for Ukraine are debatable. First, the BSF accord is apparently not the only concession promised to Moscow. Putin made it clear on his brief visit to Kyiv on April 26 that he expects the “integration” of the two countries’ nuclear power sectors (RIA Novosti, April 26). In practice this means that Russia wants to absorb Ukraine’s nuclear sector as its own nuclear industry is much stronger. Similar accords are planned for the aerospace industry. Second, Moscow did not offer any guarantees that it would continue pumping a certain volume of gas to Europe through Ukrainian pipelines, which Kyiv insisted on. This means that Ukraine may lose its transit potential once the Nord Stream and South Stream pipelines, bypassing Ukraine, are ready.